Fitch Ratings has downgraded Brazilian construction firm from B- to CC, arguing that the revelations about bribes “have exacerbated its reputational risk”.
From a press release by Fitch Ratings:
Fitch Ratings-Sao Paulo-17 January 2017: This is a correction of a release published Jan. 17, 2017. It corrects the rating for the USD800 million senior unsecured notes due 2023.
Fitch Ratings has downgraded and removed from Rating Watch Negative Odebrecht Engenharia e Construcao S.A.’s (OEC) ratings, including its foreign and local currency long-term Issuer Default Ratings (IDRs) to ‘CC’ from ‘B-‘ and its national scale long-term rating to ‘CC(bra)’ from ‘BB-(bra)’.
Fitch has also downgraded to ‘CC/RR4’ from ‘B-/RR4’ approximately USD3.1 billion issuances of Odebrecht Finance Ltd. (OFL), which OEC unconditionally and irrevocably guarantees. The ‘CC/RR4’ rating of OFL’s unsecured public debt reflects average recovery prospects in the event of a default, ranging between 31% to 50%.
A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The downgrades reflect the increasing and substantial challenges OEC faces in 2017 to restructure its activities and recover its cash flow generation capacity amidst a continuing cash burn for parental support. Fitch sees the company’s ability to replace its backlog as further impaired after details were published by the U.S. Department of Justice (DoJ) under a plea agreement. The information published has exacerbated OEC’s reputational risk and triggered a series of investigations in some countries where the company operates.
New Investigations
Fitch’s expectations that the plea agreement would improve the status for OEC have not materialized. Instead, it has already triggered further corruption investigations in Colombia, Ecuador, Panama and Peru, which is likely to result in the stoppage of projects under construction, suspension from participating in new public biddings and request of fine payments. These governments may uphold payments related with the ongoing contracts under scrutiny, which worsens the company’s increasing receivables balance and further pressure its liquidity. OEC will have to negotiate a solution in each of these countries in order to be able to participate in new biddings. Fitch understands all potential additional fines to be charged by other countries will be covered under the BRL3.8 billion initially negotiated by Odebrecht group.
Backlog Renewal Relevant Challenges
Fitch anticipates another year of backlog reduction for OEC in 2017 with potential to reach as low as USD18 billion by the end of the year. The Brazilian weak macroeconomic condition and infrastructure agenda combined with the company’s damaged reputational risks poses substantial concern on OEC’s capability to replace backlog domestically and abroad. By the end of September 2016, OEC’s backlog of USD21.3 billion decreased 24% from USD28.1 billion registered by the end 2015.
Fitch is also concerned with OEC’s backlog quality deterioration. As the company executes projects with payments performing as expected, it is being left with projects facing suspended or late payments. The agency estimates that approximately 42% of the company’s USD21.3 billion backlog in the third quarter of 2016 has been executed at a very slow pace (i.e. beyond 15 years to conclude).
Difficulty to Monetize Receivables
OEC continues to face difficulties monetizing receivables. Oil exporter countries have stretched contracts to reduce monthly disbursements, and BNDES has suspended the loans of projects abroad due to the corruption scandal. Receivables stopped piling up in third quarter of 2016 at the expense of revenue deceleration since second quarter 2016. In September 2016, OEC had BRL12.8 billion (USD3.9 billion) in short-term receivables.
Cash Burn for Parental Support
OEC continues to support its parent, which further pressures liquidity. In the third quarter 2016, OEC provided USD100 million intercompany loan to Odebrecht S.A., with an additional amount in the fourth quarter 2016. This support materially differs from Fitch’s initial expectation that Odebrecht S.A. would pay back the USD250 million loan to OEC in 2016. The timeframe of holding support returning to OEC is uncertain as it depends on the group’s sale of assets strategy.
KEY ASSUMPTIONS
–Backlog falling 40% in 2016 and 6% in 2017 with execution pace slowing down;
–Net revenues falling 64% in 2016 and 15% in 2017 in BRL terms;
–EBITDA margin of 8.2% in 2016 and 8.4% in 2017 pressured by severance payments;
–Capex at 2% of net revenues for both years and no dividends distribution in 2016.