Bahia De Las Isletas Rating Lowered To 'B-' On Weaker Earnings And Liquidity; Outlook Negative

  • In response to the COVID-19 pandemic, the Spanish government has imposed a lockdown on the country, limiting movement of its citizens and closing businesses, with the aim of curbing the rapid spread of COVID-19.
  • Air traffic has also plunged in recent weeks with many airlines grounding large portions of their fleets because of the government's travel restrictions and quarantine orders, severely affecting the travel and tourism industry.
  • We expect the financial results and liquidity of Bahia de las Isletas S.L. (Bahia) to weaken from our prior assumptions because of lower volumes of passengers in the coming months affecting the ferry operator's core business.
  • Therefore, we are lowering our ratings on Bahia and its core subsidiary Naviera Armas (Naviera) to 'B-' from 'B', as well as on Bahia's senior-secured debt, keeping the recovery rating at '3', which indicates our expectation of about 65% recovery in a default.
  • The negative outlook reflects our view that Bahia's liquidity could become increasingly constrained because of potentially continued operating weakness, which would result in a downgrade within the next six months, absent offsetting measures.
FRANKFURT (S&P Global Ratings) March 24, 2020--
S&P Global Ratings today took the rating actions listed above.
Bahia's EBITDA generation and credit measures will remain constrained in 2020, given the likely sluggish passenger numbers amid the spread of the novel coronavirus and the government's lockdown.  We expect Bahia's EBITDA generation to be below our prior assumptions, given expected lower volumes of passengers in the ferry operator's core business. Our previous expectations were that sound recovery in EBITDA and credit measures would take effect from 2020.
Bahia is taking several steps to offset the anticipated weak activity:  
  • Accelerated efforts to realize synergies from the merger with Trasmediterranea;
  • Cost-saving and operational efficiency initiatives; and
  • Reorganization of its fleet and routes leading to capacity reductions.
However, we expect these measures to be more than offset by the likely depressed passenger volumes. We have revised our base case downward, predicting only moderate improvement in EBITDA before International Financial Reporting Standard (IFRS) 16 to €60 million-€70 million in 2020 (from previously €90 million-€100 million) and €80 million-€90 million in 2021 (from previously €110 million-€120 million). We had forecast €55 million in 2019. Lowered EBITDA combined with debt-funded investment in exhaust gas cleaning systems (scrubbers) to meet more stringent environmental regulation will result in adjusted debt to EBITDA of about 9.0x this year (as compared with about 10.0x we forecast in 2019), potentially improving toward 8.0x in 2021. This is commensurate with the lower-end of our highly leveraged financial profile category and the 'B-' rating.
We believe Bahia has limited capacity to generate excess cash flow, while the expansionary and IMO 2020 compliance-related investments in scrubbers will increase debt.  We forecast annual maintenance capital expenditure (capex) will remain at about €30 million in 2020 and 2021, and could be covered by operating cash flow. Expansionary- and compliance-related capex over 2019-2021 will, however, increase Bahia's debt. To comply with IMO 2020 regulations and to keep up with its closest peers, Bahia will retrofit some of its ferries with scrubbers via a total debt-funded capital investment of €65 million-€70 million over 2020-2021. This is in addition to significant expansionary capex in 2019 of about €55 million to acquire three new ferries (to be kept outside the consolidation scope) partly offset by the disposal of one vessel. We understand that Bahia will not pursue any further material discretionary investments in 2020-2021, given that its current fleet is well placed versus those of peers.
We also consider the company's liquidity to be tighter than before.   This is because of the assumed cash burn and the limitations to draw under the super senior revolving credit facility (SSRCF) caused by Bahia's continuing covenant-breach status, which will be aggravated by the expected constrained 2020 EBITDA performance. These leave the ferry operator vulnerable to further unexpected operating setbacks and dependent on securing liquidity from external sources. We think the company might benefit from government-backed liquidity lines or could dispose additional unencumbered ferries and so release cash.
The integration of less-profitable Trasmediterranea, aggravated by operating underperformance in 2019, leads to weaker profitability, which weighs on our assessment of Bahia's business profile.   We forecast Bahia's adjusted EBITDA margin likely deteriorated to 13%-15% in 2019, including the 12-month consolidation of Trasmediterranea. This compares with an EBITDA margin of 32% in 2017 for Bahia's core subsidiary Naviera prior to the Trasmediterranea acquisition. Trasmediterranea's focus on the Strait of Gibraltar and Balearic Islands, regions with more pronounced seasonality patterns and competition than the Canary Islands, as well as its less efficient operating model and higher exposure to swings in fuel prices because of less comprehensive hedging than Naviera, weigh on the combined group's profitability. We understand that management has accelerated measures aimed to partly restore profitability. We acknowledge the progress made in aligning Trasmediterranea's fuel hedge ratios with Naviera's pre-acquisition hedge levels making up for 60%-80% of the company's forward fuel consumption. This should improve visibility regarding the group's fuel expenditure in the future. Furthermore, we believe Bahia will realize integration synergies thanks to, for example, route network optimization, personnel restructuring to eliminate duplicated tasks, and rationalization in other areas such as branch network, purchase and repairs, marketing, insurance, and audit. If implemented effectively, these measures could result in €50 million run-rate synergies by 2021.
Bahia's focus market has more favorable fundamentals than the traditional shipping industry.   This is because of generally more stable demand and pricing, as well as lower capital intensity. While we view the overall ferry industry as mature and competitive, we consider competition among ferry operators in Spain as less intense and more rational than in Italy where, for example, Bahia's rated peer, Moby SpA (SD/--/--) operates. This is due to, among other factors, a more balanced distribution of market shares by route.
The negative outlook reflects our view that Bahia's liquidity could become increasingly constrained because of potential continued operating weakness, resulting in a downgrade within the next six months, absent corrective actions to bolster liquidity sources.
We would downgrade Bahia if we think the company's EBITDA and cash flow generation will fall short of our base case, and its liquidity deteriorates such that the ratio of liquidity sources relative to uses indicates a material shortfall for the coming 12 months, absent offsetting measures.
This could occur if the novel coronavirus cannot be contained and depressed passenger volumes continue for a long time. This could also stem from intensified competition in the Spanish ferry industry, Bahia's inability to pass through the IMO 2020-related fuel price inflation, or lower-than-expected synergy gains.

We could revise the outlook to stable if Bahia manages to outperform our forecast thanks to a successful integration of Trasmediterranea, with realized synergy gains exceeding our base-case assumption of €50 million, or thanks to higher-than-expected passenger volumes as the pandemic is brought under control faster than expected, which we think would allow Bahia's free operating cash flow to reach break-even levels. New government-backed liquidity lines or disposals of ferries would also likely bolster Bahia's financial flexibility and would likewise result in our revising the outlook to stable.
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