The COVID-19 pandemic is severely reducing the financial flexibility of Latin American (LATAM) corporates as most have limited capacity to withstand cash flow pressures due to weak free cash flow (FCF) generation and an inability to further cut capital expenditure (capex), according to Fitch Ratings. The substantial economic contraction caused by the health crisis, continued political uncertainty and the effect of protectionism on cross-border trade are credit headwinds that have resulted in a record number of negative rating actions.
Most companies were weakly positioned, in terms of cash flow generation and capex flexibility, at the start of the health crisis, based on Fitch's analysis of comparative annual credit statistics over the past five years. Reduced demand and lower commodity prices are adversely affecting revenue, liquidity and financial flexibility.
Median FCF margins were negative across every country in 2019, with the exception of Chile and Mexico where discretionary cash flow was still only modestly positive. By comparison, in 2017, median FCF was neutral to positive for most countries, with the exception of Argentina where issuers have faced difficult operating conditions due to the deteriorating local macroeconomic environment and political turmoil for several years.
Issuers rated in the ‘A’ category were the strongest cash generators with a median FCF margin rising to the highest in five years at 5.6% in 2019. However, only about 5% of the 218 rated LATAM corporates with cross-border debt issuance sport such a rating. Most of these companies are domiciled in Mexico and include AC Bebidas and Kimberly Clark de Mexico with FCF margins exceeding the median at 7.9% and 5.8%, respectively.
Negative cash flow margins
FCF margins were negative across most sectors in 2019, with the exception of consumer discretionary, consumer staples and energy. FCF margins in energy turned modestly positive in 2019, after most companies were burning cash since 2015. The energy sector is one of the most vulnerable in the current downturn due to the effects the pandemic and oversupply had on oil prices. Fitch’s 2020 West Texas Intermediate oil price assumption is US$27.00 per barrel (bbl) as of April, down more than 35% compared with the ratings agency's December 2019 pre-virus 2020 assumption of US$42.50/bbl.
Fitch Ratings' comparative statistics data indicates there is limited room to improve FCF by reducing capex. Most companies have already cut growth capex and are spending mainly for maintenance. Issuers in most countries reduced investments during 2019 to preserve FCF, leaving them in an extremely tight position to free up liquidity via capex reductions during the pandemic.
Fitch notes that Chilean issuers are in pure maintenance capex mode with median capex/depreciation, depletion and amortisation (DD&A) at around 1.0x, down from 1.6x in 2015. The decline in spending has been even more pronounced in Peru, where the ratio was 0.7x in 2019 compared with 2.3x in 2015. Since 2015, median capex/DD&A has fallen to 1.1x from 1.5x in Mexico, to 1.2x from 1.4x in Brazil, to 1.3x from 1.4x in Colombia, and to 1.4x from 2.0x in Argentina.
Median capex/DD&A declined for most sectors over the past five years as 48% of issuers reported capex/DD&A at 1.0x or below in 2019. With the exception of the real estate, utilities and energy sectors, median capex/DDA is at or near maintenance level. Medians fell to 1.0x or below for issuers within transportation, telecommunications, materials, industrials, consumer staples and consumer discretionary sectors.
Thirty-five issuers have been downgraded at the parent level from March 12 to May 12, since the pandemic hit the region, and approximately 35% of international Issuer Default Ratings across all rating levels currently have a Negative Rating Outlook or are on Rating Watch Negative, suggesting additional downgrades are likely.
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