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Fitch Affirms Cyrela's IDR at 'BB-'; Outlook Stable
December 1, 2017 / 5:44 PM / 16 days ago

Fitch Affirms Cyrela's IDR at 'BB-'; Outlook Stable

(The following statement was released by the rating agency) RIO DE JANEIRO, December 01 (Fitch) Fitch Ratings has affirmed Cyrela Brazil Realty S.A. Empreendimentos e Participacoes' (Cyrela) Foreign and Local Currency Issuer Default Ratings (IDR) at 'BB-'. At the same time, Fitch has affirmed the long-term national scale at 'A+(bra)'. The Rating Outlook for Cyrela's corporate ratings is Stable. Cyrela's ratings reflect the company's strong business position and conservative financial strategy, supported by a conservative capital structure, a historically strong liquidity and an adequate debt profile for the industry risks. Cyrela's financial flexibility is well superior compared with the majority of its peers in the industry. The ratings are limited by the volatile nature of the industry and operating cash flow generation, strongly dependent on macroeconomic conditions. Over the last couple of years, the severe economic environment in Brazil materially affected the homebuilding industry, which resulted in the weakening of Cyrela's operating margins and a substantial increase in leverage that has been historically low. The ratings consider Fitch's expectation of a gradual recovery in Cyrela's cash flow generation during 2018. In Fitch's opinion, the expected reduction of costs from projects under construction, the expected volume of project deliveries in 2017 and 2018 and inventory sale should continue to benefit operational cash generation. The analysis also incorporates an expected reduction of net leverage to historical levels during 2018. Cyrela is exposed to the cyclicality and volatility of the homebuilding industry, which is highly correlated with the local economy. Fitch believes the homebuilding industry is strongly vulnerable to economic slowdown, unemployment and interest rates, consumer confidence and restrictions in lines of credit. The sector is also subject to a volatile demand and strong working capital needs to support the long cycle of its business. Fitch expects a gradual improvement in the fundamentals for the homebuilding sector in 2018, with a slow recovery of business environment. This improvement is based, among others, in Fitch's projections of 2.5% GDP growth in 2018 and strong interest rates reduction and inflation in Brazil during 2017. The consumer confidence recovery and slight reduction in the population indebtedness should also benefit demand. However, demand improvement should be slow. KEY RATING DRIVERS Cash Flow Generation to Slowly Improve: Fitch expects cash flow generation to gradual improve in 2018, supported by project deliveries and sale of inventory. Cyrela's cash flow generation remained pressured by weak operating margins and sales cancellations. Fitch estimates that Cyrela generated CFFO of about BRL400 million in the LTM ended September 2017, excluding the impact of the deconsolidation of one of its controlling companies (JV MAC Empreendimentos Imobiliarios Ltda), compared with BRL301 million in 2016 and BRL990 million in 2015. Free cash flow (FCF) was BRL825 million in the period, after dividends of BRL36 million and investments of BRL45 million, and was used to reduce debt. The deconsolidation of JV MAC, as it will be discontinued in the future, affected Cyrela's financials. However, the impact on the company's cash flow was neutral. Cyrela's operational cash flow is inflated by about BRL500 million, and this impact was offset by a reduction in the same proportion in other investments, resulting in a neutral impact on the cash at the end of the period. In Fitch's opinion, Cyrela will preserve a more defensive and conservative strategy for project launches until it has a clearer signs of more favourable economic conditions, with annual project launches up to BRL3 billion and concentrated in Sao Paulo. Stronger FCF generation could lead to higher dividend distribution. However, Cyrela will have the challenge to increase project launches, manage higher working capital needs and construction costs of new projects, as well as reduce the company's high inventory of finished units, in a business environment with still slow recovery. As of Sept. 30, 2017, the company had receivables that will mature in the next 24 months, net of cost to be incurred, of BRL1.5 billion, a strong position to face SFH debt maturities even considering the high level of finished inventory. Programmed project deliveries of BRL4.7 billion up to the end of 2018 may also benefit the company's cash flow. Cyrela delivered BRL2.8 billion in the first nine months of 2017 and BRL6.1 billion in 2016. Gradual Improvement in Operating Margins: Cyrela's operating margins significantly reduced since 2015, and Fitch expects adjusted EBITDA (excluding financial expenses allocated to costs) to gradual recover to about BRL415 million in 2018. The company's operating margins are volatile, with strong dependence on local business environment, moment in the construction cycle due to revenues recognition method and instability of project launches. In the LTM ended Sept. 30, 2017, the company generated adjusted EBITDA of BRL238 million, a sharp reduction compared with BRL499 million in 2016 and BRL855 million in 2015. EBITDA margin reached its historical lower level of 8.5%. This reduction was due to still high sales cancellations, strategy to stimulate inventory sale with discounts and a provision of BRL122 million due to an accident in Grand Parc project in Vitoria, recognized by Cyrela during the second quarter 2017. Excluding this non-recurring event, adjusted EBITDA would be about BRL360 million, with an EBITDA margin of 12.9%. High Finished Inventory Remains a Concern: Despite improvements in important macroeconomic variables, the sector's business environment still does not present considerable positive developments. As of Sept. 30, 2017, total inventory had an estimated market value of BRL5.2 billion and about 41% consisted of finished units. Fitch expects finished inventory to further increase in the short term, as 29% of units under construction will be delivered by the end of 2018. The delivery of BRL1.1 billion in finished inventory more than offset the BRL683 million sales of finished inventory in the first nine months of 2017 (considering 100% participation). Cyrela's sales speed remained low in 2017, pressured by low project launches and high sales cancellations. The average sales over supply ratio, net of cancellations, was 8.5% per quarter in the first nine months of 2017, compared to 8.9% per quarter in 2016 and 10.5% per quarter in 2015 Leverage to Reduce: Fitch expects net leverage to return to historical levels during 2018. Cyrela's weak operating results led to a leverage increase in the last couple of years. In the LTM ended September 2017, net debt/adjusted EBITDA ratio was 4.3x, compared with 3.1x in 2016 and an average of 1.8x between 2013 and 2015. Excluding the provision due to an accident in Grand Parc project, net leverage was 3.2x in the LTM ended September 2017. As of Sept. 30, 2017, total debt was BRL3.1 billion and net debt was BRL1.5 billion, compared with net debt of BRL1.7 billion in December 2016. The cash flow ratio, measured as total receivables on the balance sheet plus total inventory plus revenue to be booked over net debt plus acquisition of property for development plus cost to be incurred of units sold remained strong at 3.5x in September 2017, above the industry's average. Volatile Business Environment: Fitch expects a gradual improvement in the fundamentals for the homebuilding sector in 2018, with a slow recovery of business environment. Some key factors for the industry already show signs of improvement; however, Fitch has a cautious view on demand recovery during 2018, especially for the middle and high income segments. Demand growth will depend on availability of housing credit, positive perception by homebuyers of economic recovery and expectation that housing prices have already reached the bottom. Fitch expects the positive effect in the homebuilders' financials to take longer due to the nature of the sector and its long operating cycle. DERIVATION SUMMARY Cyrela is one of the largest developers in Brazil's real estate industry, with a strong franchise and solid landbank. The company has a longstanding specialization in residential projects, with good access to appropriate funding sources for the development of its projects. Cyrela has a more conservative financial strategy than peers and historically preserved high cash reserves and extended debt amortization profile. The sector's long cash flow cycle makes liquidity a key rating factor. Cyrela's operating results were negatively impacted by the instable business environment in Brazil in the last couple of years. As the majority of Brazilian homebuilders, cancellation of sales contracts considerably increased, inventory of finished units increased and operating margins reduced. However, the magnitude and negative impact on the homebuilders' credit quality was much differentiated. Cyrela's ratings incorporate the expectation of a gradual recovery in operational cash flow, while other homebuilders, like Gafisa S.A. (B(bra)/Watch Negative), Moura Dubeux Engenharia S.A. (C(bra)) and Queiroz Galvao Desenvolvimento Imobiliario S.A. (C(bra)) should struggle to recover its credit metrics. MRV Engenharia e Participacoes S.A. (AA-(bra)/Outlook Stable) and Construtora Tenda S.A. (BBB+(bra)/Stable) operate in the low income segment and have been successful in preserving more conservative operating metrics. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Project launches around BRL3 billion per year; --Adjusted EBITDA margin to recover to about 14% in 2018; --Cash position to remain strong. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Return of operating margins to historical levels; --Sales cancellations and inventory reduction to more conservative levels; --Net leverage to return to historical levels. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Material reduction in operating margins; --Continued high sales cancellations negatively impacting cash flow generation; --Cash-to-short-term corporate debt coverage falls to below 1.3x; --Total receivables on the balance sheet plus total inventory plus revenue to be booked over net debt plus acquisition of property for development plus cost to be incurred of units sold ratio consistently below 2.5x. LIQUIDITY Strong Liquidity: Cyrela's ratings remain supported by the company's conservative financial strategy. The company has historically reported strong liquidity and a well-distributed corporate debt maturity profile. As of Sept. 30, 2017, cash and marketable securities was BRL1.6 billion and covered by more than 100% total corporate debt of BRL1.2 billion. The company had BRL1.9 billion of total debt due by the end of 2018 and BRL651 million due in 2019, of which BRL653 million and BRL366 million, respectively, are related to corporate debt. Cyrela has an adequate debt profile, with 62% of total debt composed of credit lines from SFH (Housing Financial System). The company has no exposure to FX risk and total debt is denominated in reais. FULL LIST OF RATING ACTIONS Fitch has affirmed Cyrela's ratings as follows: Cyrela Brazil Realty S.A. Empreendimentos e Participacoes --FC IDR at 'BB-'; --LC IDR at 'BB-'; --Long Term National Scale at 'A+(bra)'. The Rating Outlook for Cyrela's corporate ratings is Stable. Contact: Primary Analyst Fernanda Rezende Director +55-21-4503-2619 Fitch Ratings Brasil Ltda. Praca XV de Novembro, 20 - Sala 401 B - Centro - Rio de Janeiro - RJ - CEP: 20010-010 Secondary Analyst Jose Roberto Romero Director +55-11-4504-2603 Committee Chairperson Ricardo Carvalho Senior Director +55-21-4503-2627 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity are listed below: --Fitch excludes financial expenses allocated in the costs from EBITDA calculation. --Fitch considers long-term marketable securities as cash. Media Relations: Benjamin Rippey, New York, Tel: +1 646 582 4588, Email: benjamin.rippey@fitchratings.com. 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