May 24, 2017 / 7:03 AM / 6 months ago

Fitch Places Accor on Rating Watch Evolving

(The following statement was released by the rating agency) LONDON, May 24 (Fitch) Fitch has placed Accor SA's (Accor) Long-Term Issuer Default rating (IDR) and senior unsecured rating of 'BBB-' on Rating Watch Evolving (RWE). A full list of rating actions is at the end of this commentary. Turning HotelInvest (HI) into a subsidiary and selling a majority stake will effectively make Accor a truly asset-light hotel operator, generating recurrent management contract and franchise fees. At present, we expect the balance of risks to be skewed to a positive rating action, with either an affirmation at 'BBB-' with a Positive Outlook, or an upgrade to 'BBB' upon completion of the split and HI sale process. Management has not yet announced clear parameters defining the company's financial policies post-deconsolidation of HI. Therefore Fitch will resolve its RWE once it has a clearer understanding of the company's financial targets. Fitch views Accor's strong commitment to an investment-grade rating as credit-positive, but the RWE signals the risks, albeit small currently, that a large portion of disposal proceeds may be used for shareholder remuneration, keeping leverage high over the rating horizon. Accor's profitability should be more resilient by virtue of the recurring profit stream derived from management contracts, despite its increasing exposure to luxury hotels which are inherently cyclical. KEY RATING DRIVERS HotelInvest Deconsolidation: Accor plans to sell a majority stake in HotelInvest (HI) to third parties and deconsolidate HI, but the percentage could range from 51% to 80%. If Accor reduces its stake in HI to a minority share, we would deconsolidate HI from the group and add back the pro rata dividends from the HI business. This could be positive for Accor's credit profile, mainly due to a reduction in lease expenses, cash-flow volatility and capital intensity. Accor will complete turning HI into a subsidiary in June, and expects the deconsolidation to be effective at the subsequent sale of a majority stake. HI would have EUR2.0 billion term loans and a EUR1.6 billion available credit facility for financing future capex. The project to turn HI into a new legal entity will accelerate the group's "twin track" strategy, eventually shifting the risks and rewards associated with property ownership to investors who prefer real estate. More Resilient Asset-light Business: The remaining Accor's business model post-split will become less capital-intensive with mainly fee-based businesses in management and franchise contracts under HotelServices, and increasingly less reliant on HI. Over time, HI's importance within Accor's room portfolio will be reduced as HI plans to dispose some of its assets, representing around 25% of its room portfolio. The asset-light model will mirror that of US lodging groups. The recurrent fee nature helps to mitigate revenue and EBITDA volatility during a period of sharp occupancy rate declines, which could occur should security concerns re-emerge in Europe. High Leverage to Moderate: Fitch estimates that Accor's FFO gross adjusted leverage will increase temporarily in 2017 after excluding discontinued operations. However, we expect low FFO net adjusted leverage because of a high cash balance after the sale of HI. The overall leverage metrics with lower lease liabilities would clearly improve compared to those metrics prior to the separation. The level of cash left in the business, which Fitch would consider readily available for debt service instead of being earmarked for acquisitions or shareholder remuneration will be critical as we expect initially a wide gap between gross and net leverage metrics (above 5.5x/1.8x respectively for 2017). If Accor pursues a conservative financial structure post-split, and uses the proceeds from the sale of its majority stake in HI for debt servicing or for value-accretive acquisitions to solidify its already solid business risk profile and enable leverage to trend to 3.0- 3.5x by end-2020, this will lead to at least one-notch upgrade to 'BBB'. Stronger Position in Luxury Segment: We consider Accor's strategy of moving more upmarket will make its business model more competitive relative to disruptive hospitality operators. Premium and upscale hotel guests (both business and leisure) are generally willing to pay for high-quality services which Airbnb does not offer. In 1Q17 Accor's revenue exposure to the luxury and upscale segment increased to 44% of total on a HotelServices standalone basis, from 26% in 2016. While Fitch views the luxury hotel business as typically more exposed to industry downturns than the mid-range and budget segments, Accor will decrease its vulnerability due to the lower share of fixed costs in managing hotels. Security Concerns in France: Fitch expects security concerns to remain in place over the near term, which will put pressure on both Accor's ARR (average room rate) and its occupancy rate. We expect some recovery in RevPar (revenue per available room) to be moderate in 2017. During 2016 the number of nights spent in hotels by foreign tourists fell by 10.8% and the RevPar in Paris fell by double digits. Nevertheless, Accor's LfL (like-for-like) revenue in France was mitigated by its asset-light model. Value-Accretive Acquisitions: Fitch expects Accor will remain very active in small-sized strategic acquisitions in digital, alternative accommodation and premium service businesses. Accor has announced a total of EUR150 million in acquisitions year-to-date at a reasonable average EV/EBITDA multiple of 9x. Potential Credit Impact: Fitch expects Accor to use part of the proceeds from the sale of HI for bolt-on acquisitions and part of the proceeds for shareholder returns. The ultimate credit impact will depend on the size of shareholder returns relative to the sale of HI, the final set-up of the group and the future financial structure and policy. Fitch expects the downside risk to be limited in our projections, given the group's strong commitment to its rating, less cyclical asset-light model, and its growing FFO and FCF through expansion. DERIVATION SUMMARY Accor's 'BBB-' is well positioned relative to European competitors Melia Hotels International and NH Hotel Group SA (B/Positive) on each major comparative. It has a slightly weaker competitive position than major global peers like Marriott (BBB/Positive) and Intercontinental Hotel Group (not rated), based on number of rooms and geographical diversification. It has a reasonable financial profile, although not as strong as asset-light and FCF cash-generative groups such as Marriott. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - room increases, rather than occupancy, remain the key driver for revenue growth over the next two years; -. we expect group profitability to improve after the deconsolidation of HI; -. we project a moderate recovery in France beginning in 2H17 and in Brazil in 2018; - cash tax of EUR300 million from the sale of HI over 2017 and 2018; - annual synergies of EUR65 million from the acquisition of Fairmont Raffles Hotels (FRHI) to be achieved in 2019 as per management guidance; - disposal of 55% of HI and the use of proceeds for value-accretive acquisitions and shareholder returns; - dividend policy remains unchanged; - moderately improving working capital variation from 2017 in a pure asset-light model; - equity credit of 50% given for EUR900 million (EUR887 million book value) subordinated hybrid perpetual bond. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating (BBB) Action -Fitch FFO lease adjusted gross leverage (adjusted for variable leases ) below 4.0x (2016: 3.8x) and lease-adjusted net debt /EBITDAR ((adjusted for variable leases) ratio below 3x on a sustained basis (2016: 4.6x) -Lease-adjusted EBITDAR/gross interest plus rents ratio of above 2.5x (2016: 2.8x) -Sustained positive free cash flow (FCF) (2016: positive EUR115 million). Future Developments That May, Individually or Collectively, Lead to Negative Rating (BB+) Action -A sharp contraction in profitability leading to group EBIT margin below 7%, which is highly unlikely for a pure asset-light mode; -FFO adjusted gross leverage (adjusted for variable leases) above 5.0x and lease adjusted net debt/ EBITDAR (adjusted for variable leases) above 4.5x on a sustained basis -Lease-adjusted EBITDAR/gross interest plus rents of below 2.0x - Sustained negative free cash flow (FCF) LIQUIDITY Strong Liquidity: The group continues to retain high financial flexibility for its rating. The Company obtained the consent of the lenders of the revolving credit facility whose amount will be reduced from EUR1.8 billion to EUR1.2 billion upon the completion of the separation. At end-2016, Accor had EUR1.1 billion of readily available cash which will be sufficient to cover EUR732 million short-term debt, and Fitch-projected EUR39m positive FCF in 2017. We have excluded 5% of Accor's cash and cash equivalents as restricted cash which are cash in Accor's subsidiaries outside OECD countries. Fitch estimates that Accor's wide geographic presence greatly limits the business seasonality and Accor cash balance should not be affected by working capital movements. FULL LIST OF RATING ACTIONS Accor SA --Long-Term IDR: 'BBB-' placed on RWE --Short-Term IDR: 'F3' placed on RWE --Senior unsecured long-term rating: 'BBB-' placed on RWE -- EUR900 million subordinated hybrid perpetual bond: 'BB' on RWE Contact: Principal Analyst Maggie Cheng, CFA Associate Director +44 20 3530 1689 Supervisory Analyst Jean-Pierre Husband Director +44 20 3530 1155 Fitch Ratings Ltd 30 North Colonnade London E14 5GN Committee Chairperson Giulio Lombardi Senior Director +39 02 879087 214 Summary of Financial Statement Adjustments Leases: Fitch has adjusted the debt by adding 5.6x of yearly operating lease expense related to long-term assets (EUR616 million in 2016). This adjustment is related to variable leases (by deducting 25% from the total annual lease commitments). Cash: Readily available cash: We have adjusted available cash at end-December 2016 to reflect restricted cash of EUR59 million as in some non-OECD subsidiaries these are subject to more FX regulation. Hybrids: Fitch has applied 50% equity credit to the EUR887 million book value of the subordinated hybrid perpetual bond. This is driven by the unconstrained ability to defer coupons, subordination and the absence of covenants. 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