1. Latin American Corporate Credit
Outlook 2016: Brazil's Recession
Continues To Drag Down The Outlook
For The Region
Primary Credit Analyst:
Diego H Ocampo, Sao Paulo (55) 11-3039-9769; diego.ocampo@standardandpoors.com
Secondary Contacts:
Luis Manuel M Martinez, Mexico City (52) 55-5081-4462; luis.martinez@standardandpoors.com
Jose Coballasi, Mexico City (52) 55-5081-4414; jose.coballasi@standardandpoors.com
Table Of Contents
Growth Will Likely Remain Weak, Though The Effect On Latin American
Ratings Will Be Mixed
Macroeconomic Outlook
Financing Conditions
Risks And Imbalances
Sovereign Trends
Negative Bias Mounts As Commodities Slump And Brazil's Economy
Worsens
Building Materials Credit Outlook: Stable
Consumer Products Credit Outlook: Negative
Forest Products: Stable
Metals And Mining Credit Outlook: Stable With Negative Bias
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2. Table Of Contents (cont.)
Oil And Gas Credit Outlook: Stable With Negative Bias
Retail Credit Outlook: Stable
Telecommunications Credit Outlook: Stable
Transportation Cyclical Credit Outlook: Stable With Negative Bias
Utilities Credit Outlook: Stable To Negative
Related Research
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3. Latin American Corporate Credit Outlook 2016:
Brazil's Recession Continues To Drag Down The
Outlook For The Region
Growth Will Likely Remain Weak, Though The Effect On Latin American
Ratings Will Be Mixed
Standard & Poor's Ratings Services expects credit conditions in Latin America and the Caribbean to weaken further
going into 2016, though effects on ratings will vary by country and sector. This is consistent with the expectations we
cited in our last report (see "Credit Conditions: Latin America Buffeted By Winds From China And Brazil," Oct. 15,
2015). Headwinds for the region remain a mix of internal factors (the recession in the Brazil, weak growth elsewhere)
and external factors, including refinancing risk associated with capital market volatility (related to China, U.S. Fed
policy, and geopolitical risks) and ongoing low commodity prices.
Overview
• We have lowered our real GDP forecasts for Latin America to negative 0.3% from negative 0.2% for 2015 and
to positive 0.5% from positive 0.9% for 2016; both changes mainly stem from the worsening outlook for the
Brazilian economy.
• Macroeconomic conditions in Brazil have deteriorated further in recent months, with rapidly growing inflation,
consumer and business confidence continuing to fall, and persistent political instability. As a result, we have
lowered our real GDP forecasts for Brazil to negative 3.2% from negative 2.5% for 2015 and to negative 2.0%
from negative 0.5% for 2016.
• Elsewhere in the region, a modest uptick in global trade and stabilizing commodity prices will drive a gradual
recovery in real GDP growth in 2016, though risks to macroeconomic stability remain skewed to the downside.
• Commodity prices and currency depreciation continue to have a mixed impact on Latin America and
Caribbean sovereigns.
• Negative bias is mounting over Latin American corporate ratings as the Brazil's macro worsens and
commodity prices decline
• Metals and Mining and Oil & Gas credits face above-average downside risks due to receding cash flows on the
back of falling prices
• Utilities' ratings in Brazil also face downside pressure due to the negative outlook on the Sovereign
• Reduced market access and gloomy growth prospects would drive credit quality in 2016.
Macroeconomic Outlook
External conditions will be less of a drag on Latin American growth in 2016
We have lowered our Latin America real GDP forecasts for 2015 and 2016 mainly because of the worsening outlook
for the Brazilian economy. However, for most major economies in the region, we continue to expect a mild recovery in
growth in 2016 as the firmly negative external conditions this year become less pronounced. We believe that an
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4. expected stabilization in commodity prices following the sharp decline this year--combined with an improvement in
global trade as growth in most developed economies picks up--will contribute to a modest recovery in GDP growth in
most of Latin America in 2016.
The Brazilian recession continues to deepen
Macroeconomic data suggests that the Brazilian recession deepened in the second half of 2015, with real GDP
declining by 4.4% year-over-year in the third quarter of 2015 following a 3.0% year-over-year contraction in real GDP
growth in second-quarter 2015. The deterioration in macroeconomic conditions has stemmed from a decline in
consumer spending and fixed investment amid elevated inflation, tight monetary policy, and declining business
confidence levels as political instability continues. Headline inflation breached the 10.0% year-over-year mark in
mid-November, and the Brazilian central bank signaled that it will keep the Selic target rate unchanged at 14.25% for a
prolonged period. This, combined with rising unemployment, will likely result in another contraction in private
consumption in 2016. Higher unemployment will gradually drive inflation lower, which will allow the central bank to
ease monetary policy and return GDP growth to positive territory, though we do not expect this until 2017.
Elsewhere in the region, conditions are slowly improving
Across Latin America, domestic demand deteriorated sharply in the first half of the year. However, available data for
the second half of 2015 reveals that domestic demand in most of the region's major economies (excluding Brazil) has
either stabilized or improved. Domestic demand in Mexico has been recovering, with record-low inflation and falling
unemployment supporting robust retail sales. In Chile, consumer spending is also slowly recovering, and fixed
investment was stronger than expected in the third quarter, expanding by 7.1% year-over-year after falling by 3.3% in
the second quarter. In Peru, private consumption has remained relatively resilient, though fixed investment continues
to remain a main drag on headline growth. In 2016, net exports will likely become less of a drag on growth across most
of the region as global trade improves, which--combined with recovering domestic demand--will drive modestly
stronger GDP growth.
In Colombia, we forecast mildly stronger real GDP growth of 3.2% in 2016 compared with 2.9% in 2015 due to several
factors. First, the reopening of the recently expanded Cartagena oil refinery on Oct. 21 will boost manufacturing
production in the coming quarters (oil refining has averaged about 20% of Colombia's total manufacturing output in
recent years). Second, consumer price inflation, which surged to 5.9% year-over-year in October from 3.8% in January,
will likely moderate next year as the impact on prices of both unfavorable weather conditions and a sharp depreciation
of the currency becomes less acute. Third, we expect oil prices to stabilize next year, which will lessen the negative
drag that exports have had on GDP this year. However, an increasingly challenging fiscal picture, following a collapse
in oil-related revenue, will keep risks to our growth outlook for Colombia firmly to the downside, especially if financing
for key infrastructure projects under the 4G program fails to materialize.
"Gradualism" no longer our baseline scenario for Argentina
We have revised our macroeconomic outlook for Argentina following the victory by opposition presidential candidate
Mauricio Macri in the Nov. 22 run-off election. We expect that a Macri-led presidency will result in more aggressive
policy adjustment than would have been the case under Mr. Scioli, who was expected to adopt a more gradual
approach to reforms. Some of these policy adjustments could include a devaluation of the peso, changes in tariffs to
the agricultural sector, and a more active strategy in seeking a resolution with holdouts of defaulted sovereign bonds to
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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5. regain access to international debt markets. As a result, we now forecast real GDP growth to decelerate to 1.1% in
2016 from 1.7% in 2015 as a currency devaluation drives a sharp uptick in inflation. However, we expect growth to
increase to 2.9% in 2017 as policy adjustments begin to reignite economic activity.
Table 1
Latin America GDP Growth Forecasts As Of Fourth-Quarter 2015
--Base scenario-- --Down scenario--
(%) 2014 2015 2016 2017 2015 2016 2017
Argentina 0.5 1.7 1.1 2.9 0.5 (1) 1.0
Brazil 0.1 (3.2) (2) 1.2 (4) (3) 0.0
Chile 1.8 2.1 2.8 3.4 1.5 1.8 2.2
Colombia 4.6 2.9 3.2 3.6 2.3 2.4 2.6
Mexico 2.1 2.3 3.0 3.6 1.8 2.0 2.5
Panama 6.2 6.0 5.5 5.5 5.0 4.0 5.0
Peru 2.4 2.7 3.4 3.8 2.0 2.5 3.0
Uruguay 3.5 2.5 2.0 2.0 2.0 1.0 1.0
Venezuela (3.7) (7) (5) 0.0 (8) (7) (3)
Latin America 1.1 (0.3) 0.5 2.4 (1.0) (0.7) 1.1
Table 2
Changes From October 2015 Base Forecasts
(Percentage points) 2015 2016 2017
Argentina 1.2 1.1 0.9
Brazil (0.7) (1.5) 0.2
Chile (0.0) (0.2) (0.1)
Colombia 0.4 0.2 0.1
Mexico 0.0 0.0 0.1
Panama 0.0 0.0 0.0
Peru 0.2 (0.1) (0.2)
Uruguay 0.0 0.0 0.0
Venezuela 0.0 0.0 0.0
Latin America (0.1) (0.4) 0.2
Table 3
Latin America Inflation (CPI EOP)
(% change) 2014 2015e 2016f 2017f
Argentina 22.6 20.0 39.3 20.0
Brazil 6.4 10.1 6.6 6.1
Chile 4.6 4.2 3.3 3.1
Colombia 3.4 6.0 3.8 3.0
Mexico 4.1 2.5 3.2 3.9
Peru 3.5 3.7 3.0 2.5
e--Estimate. f--Forecast.
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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6. Table 4
Latin America Interest Rate And Foreign Exchange Rates
--EOP
policy rate
(%)--
--EOP exchange
rate (per US$)--
--Average
exchange rate
(per US$)--
2014 2015e 2016f 2017f 2014 2015e 2016f 2017f 2014 2015e 2016f 2017f
Argentina 23.00 22.00 50.00 30.00 8.50 10.00 16.00 20.00 8.13 9.22 14.25 18.50
Brazil 11.75 14.25 14.25 13.75 2.70 3.94 4.26 4.59 2.35 3.34 4.11 4.39
Chile 3.00 3.25 4.00 4.50 607 700 666 646 570 655 685 662
Colombia 4.50 5.50 6.00 6.00 2,390 3,000 2,950 2,850 2,002 2,750 3,000 2,900
Mexico 3.00 3.25 4.00 4.50 14.70 16.51 16.19 16.14 13.31 15.79 16.37 16.16
Peru 3.50 3.50 4.00 4.50 3.00 3.30 3.70 3.90 2.84 3.18 3.50 3.80
e--Estimate. f--Forecast.
Financing Conditions
Financing conditions in Latin America continue to be tepid, with $65.9 billion of new corporate debt (financial and
nonfinancial) coming to market in 2015, which is the lowest annual volume in seven years. Unless an additional 10%
improvement in Latin American new issuance volumes come online in December alone, which is unlikely, we expect
that 2015's total new volume will be lower than 2009's weak showing of $72.6 billion, off a record high $141.3 billion in
2014. Financing conditions continue to be strained, particularly among countries that are net energy and commodity
exporters and those with weaker credit profiles (especially speculative-grade issuers). In fact, the Institute of
International Finance's most recent survey on bank lending conditions in Latin America fell 1.4 points to 44.5
points--the lowest level since the survey began in late 2009. With Brazil's geopolitical and economic situation
continuing to escalate, devaluing the Brazilian real to multi-year lows in the process, risk premiums for Brazilian
corporate debt will likely continue to rise amid a flight to quality by global investors.
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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7. Chart 1
Risks And Imbalances
Our top risks for Latin America remain similar to those of last quarter: Brazil's recession risk, the related slowed bank
lending and refinancing risk, and potential credit market volatility, which continues to be as much due to potential
volatility from China as from the upcoming Fed policy normalization. Persistently low commodity prices remain a risk,
particularly in light of the potential risk of a continual decline in consumer and business confidence in China.
Table 5
Top Regional Risks: Fourth-Quarter 2015
Risk level Risk trend
Brazil: recession, slowed bank lending, and refinancing risk Elevated Increasing
Credit market volatility and related refinancing risk Moderate Increasing
Persistence of low commodities prices Moderate Increasing
Risk Level may be classified as “very low,” “low,” “moderate,” “elevated,” “high,” or “very high.” Risk Trend may be classified as stable,
decreasing, or increasing.
Globally, we are monitoring the following top risks:
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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8. • We continue to believe that a spike in financial market volatility is possible as the Fed normalizes U.S. monetary
policy. Furthermore, we believe reduced corporate sector liquidity--both in the secondary and primary funding
markets--could amplify any market stresses or setbacks.
• We continue to view weaker economic growth in China as a top risk.
• Finally, we also see geopolitical concerns--highlighted by recent terrorist attacks in France--as a top global risk.
Historically, terrorist attacks similar to the recent ones in Paris (New York in 2001, Madrid in 2004, and London in
2005) have not had a large or lasting effect on consumer and business confidence per se. But more frequent and
random terrorist activity around the world could lead to a longer and deeper slide in business and consumer
confidence.
Table 6
Top Global Risks: Fourth-Quarter 2015
Risk level Risk trend
Credit market volatility from U.S. Fed policy normalization Moderate Increasing
Reduced market-making activity by dealer banks that increases secondary-market liquidity risk for investors
and raises funding costs by restricting borrowers' access to public bond markets
Moderate Increasing
Geopolitical risks: escalation in terrorist threat; Middle East turmoil, specifically in Syria; the European refugee
crisis; Brexit risk that leads to credit market volatility; and an escalation in extreme and nationalistic views that
challenges Europe’s continued economic and political integration
Elevated Stable
China's economic growth continues to slow, affecting market confidence and commodity and asset prices as
well as increasing market and currency volatility
Elevated Increasing
Risk Level may be classified as “very low,” “low,” “moderate,” “elevated,” “high,” or “very high.” Risk Trend may be classified as stable,
decreasing, or increasing.
Sovereign Trends
Commodity prices and currency depreciation have a mixed impact on Latin America and Caribbean
sovereigns
Lower commodity prices have mainly had a negative impact on South American economies, given their greater
reliance on commodity exports. By contrast, Caribbean and Central American countries have benefited from cheaper
commodities--with the exception of Trinidad and Tobago, which is a major energy exporter. Mexico has suffered from
lower fiscal revenues from the energy sector but has benefited from continued GDP growth in the U.S., which is partly
attributable to low oil prices.
The value of most countries' currencies has depreciated substantially relative to the U.S. dollar, helping to cushion the
external shock on the domestic economy. However, countries with rigid exchange rates and those that use the U.S.
dollar as their legal currency have recently experienced an appreciation, potentially reducing their long-term external
competitiveness.
Most sovereign ratings in the region continue to have stable outlooks. The notable exceptions are Brazil, Venezuela,
and Argentina (local-currency rating only), which have negative outlooks.
We lowered our long-term foreign-currency rating on Brazil to 'BB+' from 'BBB-' in September to reflect mounting
political challenges that have made it harder for the government to implement an effective fiscal correction and
contain its growing debt burden. The negative outlook reflects the risk of further deterioration in Brazil's fiscal position
or potential key policy reversals, given the country's fluid political dynamics. We lowered our long-term
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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9. foreign-currency rating on Ecuador to 'B' from 'B+' in August due to deterioration of its external and fiscal metrics. We
have not lowered the ratings on other commodity exporters in South America (Chile, Peru, Colombia, and Bolivia) but
are tracking the fiscal, external, and political effects of adverse terms of trade and falling capital inflows into these
countries.
Table 7
Latin American Sovereigns And International Public Finance Outlook
Current business
conditions
Business conditions
outlook Financial trends outlook Sector outlook
Brazil Weak No change Same Negative
Mexico Weak No change Same Stable
South America (except Brazil) Satisfactory No change Same Stable
Central America and the
Caribbean
Weak No change Same Stable
Mexico IPF Satisfactory No change Same Stable
Argentina IPF Weak No change Lower Negative
Brazil IPF Very weak No change Significantly lower Negative
Negative Bias Mounts As Commodities Slump And Brazil's Economy Worsens
The net negative ratings bias for the Latin American corporate portfolio has substantially increased in the past 12
months, mainly due to our Sept. 9, 2015, downgrade of Brazil to speculative levels and gloomier growth prospects
amid lower commodity prices and higher borrowing costs. The region's economy is largely exposed to China and its
slipping industrial growth rates are hurting prices of key commodities exports such as iron ore, copper, oil, and gas.
While some key markets such as Mexico, Chile, Peru, and Colombia are still enjoying solid economic growth and fairly
favorable business conditions, other economies are struggling, namely Brazil, Venezuela, and Argentina. The political
turmoil in Brazil and particularly the corruption investigations that followed the "Lava-Jato" scandal in government
owned company Petrobras are taking its toll on several sectors of the Brazilian economy. Many Petrobras' suppliers
are facing payment delays as the company reduces its capital expenditures program and undergoes cost-cutting
initiatives. Meanwhile, Argentine corporations hope that the new administration of Mauricio Macri will turn around the
country's lackluster economic prospects.
These factors, along with a potential rise in interest rates for dollar-denominated debt if the Federal Reserve moves
away from the quantitative easing, are exacerbating exchange rate volatility and curbing investors' appetite for the
region. Weaker currencies don't represent a meaningful threat to our corporate portfolio because main markets have
liquid hedging instruments. However, refinancing risks are mounting and remain a threat to Latin American corporate
issuers towards 2017, when more than $20 billion of international corporate debt comes due; international bonds'
maturities seem more manageable for 2016, at $14 billion.
Issuers with a negative outlook or on CreditWatch negative outnumbered positive ones, resulting in a net negative
bias. The negative bias was at 29% of total issuers at the end of November 2015, significantly higher than 11% at a
year-earlier date (see charts 1 and 2). The majority of ratings clustered in the 'BB' category (see chart 3).
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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13. Chart 5
Negative bias spread over key sectors
The negative bias is spread over all key industry sectors of the region, with a larger proportion in heavy industries,
mainly due to Brazil's recession and lower commodities prices. Still soft industries are performing relatively well in
most countries, including Brazil. However, we believe there is downside in that country as well for retailers and service
providers if unemployment rate keeps rising. Our portfolio of building materials companies bears lower risks in 2016
because issuers are based in countries that exhibit healthy growth potential, such as Panama, Mexico, and Peru.
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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14. Chart 6
Building Materials Credit Outlook: Stable
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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18. Chart 10
Our median rating for a company in Latin America's building materials industry is 'BB'. Our outlook for this industry is
stable with a negative bias. We view business conditions as remaining satisfactory for the next 12 months. However,
financial trends for the next 12 months indicate higher risk.
Base-case assumptions
A significant infrastructure and housing deficit mostly drives demand for building materials in Latin America. As
demand for building materials follows a trend in individual countries, we expect rating trends to vary in the region, but
will largely remain stable.
In our opinion, Brazil is the only country in the region that faces a negative rating trend because we expect a high
single-digit contraction in cement demand in 2016. The recent corruption investigations of most of the country's
biggest engineering and construction conglomerates should continue to delay the execution of many infrastructure
projects, depressing demand. In addition, high inflation, increasing unemployment, and tighter credit availability are
taking a toll on household income, which would also plunge demand for housing.
We expect mid-single digit growth in Mexico's building materials industry in 2016. The market is benefitting from the
dynamism of the homebuilders because we expect a double-digit growth in housing inventory levels. Also, the
government's efforts to accelerate the deployment of the national infrastructure program will bolster growth. However,
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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19. we expect risks during 2016 related to a 20% cut in the government's budget for infrastructure projects, which could
delay construction in key sectors such as roads, airports, ports, and energy. Infrastructure projects represent 30%-40%
of cement consumption in Mexico, and housing about 40%.
Volume growth would remain flat or rise at by single digits in Colombia, Panama, and Peru mainly due to a more
modest economic performance, a delay in capital investments, and the completion of major infrastructure projects.
Standard & Poor's expects pressures related to tight fiscal conditions that would constrain these governments' ability
to allocate incremental public resources for infrastructure development in 2016.
Key risks
Weaker-than-expected macroeconomic conditions in the region. We consider that a 100 basis point decline in
economic activity in the region would result in a similar drop in demand growth. Such a drop would result in a loss of
economies of scale, which would in turn weaken operating margins. Therefore, we would expect more limited cash
flow generation and potentially weaker credit metrics.
Lower government budget for infrastructure spending. Capital investments to support infrastructure projects in the
region have declined to approximately 2.0% of GDP in 2015 from 3.5% in 2012. If oil prices remain at current levels,
we expect the public sector to struggle to increase spending on infrastructure development.
Refinancing. Although some building materials companies have been proactive in debt refinancing over the past
couple of years, we believe that volatile financial markets could compromise the sector's ability to access capital and
refinance medium-term debt maturities, which could result pressure its liquidity.
Consumer Products Credit Outlook: Negative
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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23. Chart 14
Base-case assumptions.
Latin America's economic slowdown will restrict the consumer product companies' ability to expand volumes in 2016.
Brazil's recession, the slower-than-expected growth in Peru, Chile and Mexico, and lingering uncertainties over
Argentina's economic recovery should push up competition for market share, including promotional activities for the
branded non-durable producers. On the other hand, the lower input prices and cost cuts, which were implemented in
the past few quarters, should continue bolstering margins. In our view, this, combined with the companies' ability to
pass on inflationary pressures to prices, should generate mid- to low-single digit revenue growth, with a fairly flat to
slightly improving margins.
The agricultural commodity sector will struggle to lift up revenue growth as grain prices are likely to remain at fairly
low levels, due to weaker demand from Asia and to sizable global grain production. As a result, sugarcane companies
should continue to struggle amid small operating cash flow generation. However, the mitigating factors are the likely
greater crushing volumes due to the region's better weather conditions for the harvests and higher ethanol prices,
stemming from the strong demand for the product. Also, revenues will grow because sugarcane producers export a
portion of their production, which generate higher dollar-denominated revenues, and prices have lately recover
somewhat. A more sustained and significant improvement, however, will continue to depend on global production and
consumer demand, public subsidies for the harvests investments, and the companies' operating ability to produce amid
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Latin American Corporate Credit Outlook 2016: Brazil's Recession Continues To Drag Down The Outlook For
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24. low idle capacity levels and adequate investments in the plantations.
The weaker currencies in Latin America should boost the exporters' revenues and EBITDA because they're dollar
denominated. Brazilian protein companies are enjoying this advantage and increasing the share of exports of total
volumes amid weak domestic consumption. Mexican consumer producers are benefiting from the stronger demand
from the U.S.
Key risks.
Slower growth, inflation, and the need to adjust prices. The slower growth, weaker macroeconomic indicators, and
fiercer competition will hamper the companies in adjusting prices to maintain margins during 2016. In addition, the
changes in consumers' preference and taste can diminish volumes of sugared drinks and other packaged foods,
stimulating promotional activities and product innovation to maintain revenues and brands' position in the main
markets. The low input costs will help support margins, but high interest rates in some regional economies can reduce
operating and free cash flow generation mainly among Brazilian entities. Working capital management can also be a
relief, as companies have focused on cost-cutting initiatives, which overall should result in fairly stable margins in
2016.
Currency mismatch can hurt credit metrics.Volatile currencies will continue to act as a drag on balance sheets and
profitability. Companies with foreign currency debt are confronting weakening credit metrics and higher interest
burden, which can result in liquidity concerns amid the lack of derivative uses to soften currency risk exposure. We
currently don't see this as a major risk for the rated companies in this sector. However, several regional sugarcane
companies have struggled with high amount of dollar debt, resulting in recent defaults and downgrades. This was
mainly because the revenues and EBITDA don't enjoy the currency benefits as fast as dollar debts, so a sharp
depreciation usually hurts metrics immediately, and then they gradually revert as exports are repriced at the new
currency rate. But if improvements don't materialize in the short term and if weaker currencies trigger debt
acceleration due to covenants' triggers, negative rating actions are possible.
M&A activity may drive rating actions for large companies. The sector has historically grown through acquisitions in
the past. We continue to see large and well capitalized companies doing so, as seen in recent acquisitions of Brazilian
and Peruvian bottlers by Mexican companies and JBS S.A.'s aggressive acquisitive history. While we see credit
tightening and lesser appetite for Latin American debt, the large and more global companies headquartered in the
region continues to enjoy cheap credit. Despite the weak Brazilian real, we expect to continue to see a slow but
ongoing M&A activity in the region.
Forest Products: Stable
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28. Chart 18
Our outlook for the forest products sector remains stable, mainly due to favorable pulp prices and a strong dollar,
which bolsters regional pulp exports' profitability.
Base-case assumptions.
We expect favorable prices and weakening Latin American currencies to support the regional forest products
industry's performance during the next few years. Brazilian real's depreciation deepened cost reductions in late 2014
through 2015 because approximately 80% of the Brazilian producers' pulp cost is denominated in domestic currency.
Therefore, we expect Brazilian producers to remain at the top of the cost competitiveness rankings amid a further
weakening of the domestic currency through 2017. Chilean pulp producers will benefit similarly from the weaker
currency, albeit more mildly than their Brazilian peers.
On the other hand, we expect business conditions for the sector's companies to worsen in Brazil during 2016. And we
expect modest growth elsewhere in the region. The rated forest products companies in the region have some exposure
to domestic tissue, paper and packaging product markets, such as cardboard, printing and writing paper, tissue and
boxes. We expect these markets to perform modestly, taking into account Brazil's weak economy.
Finally, we expect most of the rated companies to improve their credit metrics in the short to intermediate term
because many of them recently completed their expansion plans and will now benefit from incremental cash flows
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29. from the new pulp mills. We continue to monitor investment decisions because we believe growth appetite is robust
due to solid price levels, improving margins, and attractive financing terms.
Key risks.
Global economic slowdown, particularly in China. China is a key market for pulp producers due to the large base of
tissue producers. Global tissue production has grown significantly in the past decade and has more than offset the
decline in demand for pulp from printing and writing paper producers. If China's economic growth continues to ease,
pulp demand may not rise fast enough to absorb the increased capacity. In such scenario, we may see pricing pressure
in 2016 and 2017.
We expect Latin America's muted economic growth to have greater impact on companies that focus on the paper
segment. The other industry players' exposure to the region, specifically to Brazil, will be limited.
Risk of a capacity glut in pulp markets could dent prices in the intermediate term.In our view, the risk of overcapacity
will rise in the intermediate term due to large capacity additions in 2016 and 2017. The investment in Latin American
forest products industry will boom in the next two years, and we expect combined capacity additions of 3.5 million
tons of pulp by 2017 (about 6% of the world's current supply). Examples include Klabin S.A.'s PUMA and Fibria
Celulose S.A.'s Horizonte II projects, as well as Suzano Papel e Celulose S.A.'s capacity expansions at its existing mills.
Moreover, we believe companies have appetite to invest in new capacity given relatively high returns currently. Three
additional projects may join the list in the future: Celulosa Arauco y Constitucion S.A. is studying project MAPA (1.5
million tons of BEKP to be located in Chile); Eldorado Brasil Celulose S.A. aims at increasing its production capacity by
2.3 million tons; and Suzano may seek to proceed with project Piauí for a capacity of about 1.3 million tons.
However, this greater capacity would exceed the expected global demand growth in 2016-2017 particularly in light of
the recent slowdown in pulp demand in Europe, China, and the U.S. Nevertheless, we expect most of these projects to
be very cost efficient because they will employ modern machines with high productivity rates and enjoy favorable
sourcing of raw material, which will ultimately lower the average cost in the industry. Along with our assumption of
continued rapid demand growth for tissue in China, our base-case forecast for BHKP prices range between $700 and
$730 per ton in 2016 and 2017.
Metals And Mining Credit Outlook: Stable With Negative Bias
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33. Chart 22
We have a negative outlook on almost 40% of rated Latin American metals and mining companies, mainly due to low
iron ore and copper prices and weak steel demand in Brazil.
Base-case assumptions.
With sluggish demand from China for commodities, we expect prices will remain depressed in the coming years. In
late August, we revised our price deck for the main commodities. Our working assumptions include iron ore at $50 per
ton through 2017, copper at $2.4 per pound through 2017, gold at $1,150 per ounce through 2017, and aluminum at 75
cents per pound in 2016 and 80 cents per pound in 2017. Most of these commodities are currently being traded below
our price deck, increasing pressure on the sector's credit quality.
Domestic currencies will remain weak relative to the dollar, providing some cushion to low metals prices through
lower production costs. We expect most companies to reduce their investments to maintenance levels as soon as
possible and to cut dividends and monetize non-core assets.
Key risks.
Weak metal prices will constrain credit quality. Virtually all metals are suffering from low prices. Far from a point-in
time disruption, fundamentals point to new price equilibriums that are likely to continue denting the sector's credit
quality. Industry leaders' free operating cash flows are diminishing, which leaves no option but to cut costs and
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34. investments to preserve cash and avoid debt levels from rise.
Currencies around the globe are depreciating, reducing production costs and providing some short-term protection to
metals and mining companies' profits and operating cash flows. However, the weaker currencies lead to fiercer price
negotiations in the future, so we remain skeptical on the intermediate-term outlook for most of the metals we cover.
Refinancing risks The sector's companies across all rating categories are seeing yields increase as investors' appetite
for metals and mining credits recedes. Investment-grade names such as Corporacion Nacional del Cobre de Chile and
Vale S.A. have seen their CDS spreads gone up by 50% or higher since April 2015. Also, bond issuance during this year
has been unusually low. In 2015 companies divested assets and reduced dividend payments to free-up capital.
We expect market conditions to remain somewhat challenging for rated metals and mining companies in 2016, which
may limit investment plans and force dividend cuts. Liquidity is not a major concern to our rated portfolio because
most of rated companies cluster around 'BBB' and 'BB' rating categories and hold robust cash positions.
Shrinking asset values reduce recovery prospects. Lower prices usually mean that a portion of the supply curve
becomes unprofitable while the rest of the operations lose shine in terms of cash flow generation. Such scenario,
combined with more expensive cost of capital, will shrink asset values and therefore lower recovery prospects for
debtholders.
Oil And Gas Credit Outlook: Stable With Negative Bias
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38. Chart 26
Base-case assumptions.
Despite lower oil prices, the ratings outlook on Latin American players is stable. Oil and gas companies benefit from
their relationship with their respective governments because about 50% of the rated portfolio are government-related
entities. These ratings generally move in line with the sovereign ratings due to the governments' heavy involvement in
the sector.
During this year, we revised for the third time our crude oil prices assumptions to $45 per barrel (bbl) for West Texas
Intermediate (WTI) from $65 at the end of 2014. The lower oil price assumptions reflect recent dramatic falls in futures
prices for both Brent and WTI oil. We believe some members of OPEC, particularly Saudi Arabia, are committed to
maintaining current production quotas for geopolitical reasons and to preserve market share despite softening demand
from European and Asian economies.
Key risks.
Lower crude oil prices and more restricted market access had weighed on Latin American oil and gas ratings. Although
national oil and gas companies represent about 50% of our portfolio in the region, stand-alone credit profiles (SACPs)
have weakened as a result of the steep decline of crude oil prices and a tighter access to debt markets. Brazil is
undergoing through its biggest corruption scandal with Petrobras in the center of the investigation. Due to Petrobras'
more restricted market access, a debt-laden balance sheet, and higher contingent liabilities, we revised its SACP
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39. downward during the year.
Weak cash flow from operations has increased leverage. Latin American oil and gas companies' weaker cash flow
generation has pushed up their leverage. Average debt to EBITDA ratios for the sector in the region was below 3x in
2014, and we expect a peak of about 4.5x in 2015 given the current crude oil prices. However, due to our expectations
of some recovery in oil prices for 2016 and afterwards, companies' leverage should decrease to the 3.0x-3.5x range.
Increasing assets divestments to reduce debt levels. As a result of current oil price volatility, Latin American companies
have initiated several divestments of non-core assets to protect their balance sheets. Pacific Rubiales Energy Corp.
announced its divestiture of Pacific Midstream and Pacific Infrastructure for about $800 million, proceeds from which
it will use mainly to reduce debt. Moreover, Petrobras approved a $15.1 billion divestment plan for 2015 and 2016 and
one for $42.6 billion during 2017 and 2018 for divestments, business reorganization, and assets demobilization.
Lower capital spending. We believe that Latin American companies have the flexibility to adjust their capital
expenditures (capex) and cost structure to moderate the pressure on their credit profiles. They have reduced capex by
30%-40% in 2015 as a result of oil price volatility. However, this could lower production levels and cash flow
generation.
Retail Credit Outlook: Stable
Chart 27
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42. Chart 30
Our outlook for Latin American retail sector would remain stable in 2016. For Mexico, Chile, and Peru, we expect
well-positioned companies to continue posting mid- to high-single digit revenue growth and stable profitability amid
our estimates a low-single digit GDP growth and a still solid consumer spending partly stemming from low interest and
inflation rates. Our credit outlook for Brazilian companies is gloomier due to recession, increasing unemployment
rates, high inflation and interest rates, which will continue to undercut the consumer spending. As a result, Brazilian
companies' revenue growth is likely to limp while pressure mounts on their profitability.
Base-case assumptions.
We forecast Mexican retailers' same store sales (SSS) growth to be in line or slightly above the GDP growth rate, and
higher for department stores the higher. The rising consumption financing in Mexico and Chile will benefit the
retailers, especially those whose sales heavily depend on credit. Brazilian retailers' SSS will contract, which might raise
promotional activity to prevent inventory increases. On the other hand, most Brazilian companies are focusing on
cost-cutting initiatives to mitigate margin pressures.
We expect operating performance among Latin American retailers to slightly recover with EBITDA margins in the
mid- to high-single digits for supermarkets and in the low-double digits for most of the department and apparel stores
we rate. Mergers and acquisitions pace will probably remain muted. However, amid the weak Brazilian real,
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43. international players could enter the market, or domestic large players with healthy capital structures could acquire
their smaller peers that can't cope with the country's tough economy.
In general, we expect the larger and better capitalized companies to continue gaining market share thanks to the
highly-fragmented retail market in Latin America, their bargaining power with suppliers, higher investments in
advertising and in store openings, and greater ability to fund working capital needs and capex amid the region's
weaker economic performance. Due to Brazil's recession, we expect the domestic retailers to reduce the number of
store openings to curb capex levels amid expected weaker operating cash flow generation. Although at a slower pace
than in the past, we expect retailers to continue expand through new stores, which would continue to result in a free
operating cash flow shortfall in 2016. Finally, due to their ability to adjust capex and working capital needs, we expect
that most of the retailers we rate won't face an overarching liquidity risk.
Key risks
Weakening macro in Latin America. Although unlikely in our base-case scenario, deteriorating economies in Chile,
Peru, and Colombia could derail the consumer spending and increase the margin pressures on the retailers as they
would ramp up promotional activity. Such scenario could squeeze the companies' cash flow generation and
liquidity--despite their ability to adjust expansion programs and working capital needs--as well as dividend payments
among Mexican retailers.
Refinancing risk. Several retailers we rate in Latin America have significant debt maturities in 2017, some of them
dollar-denominated. These companies could struggle to refinance debt due to limited access to debt markets under
more volatile and difficult conditions, which could weaken their liquidity.
Rising interest risks. Rising interest rates could take a toll on discretionary retailers, especially department stores that
generate a bulk of sales through consumer credit. In such scenario we generally expect a reduced consumption,
requiring retailers to moderate expansion programs and working capital needs. For companies with credit
divisions/banks, we would also expect a reduction in their loans and a significant increase in their nonperforming
loans, which could weaken their cash flow generation.
High competition in a sluggish economy. The retail market remains more fragmented in Latin America than in more
mature markets in the U.S. and Europe. In Chile, Peru, Mexico, and Brazil, more than 60% of the retail industry
corresponds to mom and pop shops and/or informal markets. In response, retailers in some countries have boosted
promotional activity, which has lowered their margins. If Latin American economy deteriorates and undermines
consumer spending, the companies could increase further their promotions, which along lower revenue and EBITDA
generation, could further diminish profitability. The resultant competition could force Brazil's small players to leave the
market, resulting in higher market share for the large retailers. As such, price wars among the large players could
materialize, amid Brazil's weakening economy with demand declines.
Telecommunications Credit Outlook: Stable
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47. Chart 34
Our overall outlook on the Latin American telecom and cable sector remains stable. Low broadband and TV
penetration rates in some countries, along with higher demand for data usage, will continue to drive growth.
Base-case assumptions.
We expect modest growth among most of the carriers as a result of regulatory pressures, higher competition, and the
declining use of fixed voice in the region, which would be partially offset by higher data usage, and broadband and
pay-TV penetration. EBITDA margins will slip as a result of a stronger competition that has pressured prices; higher
subscriber acquisition costs in the wireless segment due to rapid postpaid subscriber growth that has raised handset
subsidies for some companies; and increased content charges in the pay-TV segment. We believe most the ratings will
remain stable during 2016, but M&A could drive some rating changes on individual companies.
In 2015, the regional sector experienced modest M&A activity, and we expect this trend to continue in 2016 as new
players enter Latin America.
Capex should remain at about 20% of revenues for most of the telecommunications players in the region except for Oi
and America Movil whose investments should be lower. Companies would seek to expand 4G and fiber optic
networks. The goal is to guarantee the quality of services and network expansion in order to maintain competitiveness.
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48. Key risks
Regulatory risks remain. Most of Brazil's telecom companies are waiting for the domestic regulator's decision in the
upcoming months to sign a legal instrument, called Termo de Ajustamento de Conduta (TAC), through which the
companies would exchange accumulated/unpaid fines for capex. The regulator originally planned to make this
decision in November 2015, but it delayed it. In general, these accumulated fines were related to poor service quality
provided to consumers, so the investments, as part of the TAC, should be focused on improving service quality. These
investment shouldn't represent an increase in companies' capex levels because the latter already encompass plans to
improve network and, consequently, quality.
Additionally, the regulator is likely to complete its periodic review of the concession contracts for fixed telephony in
the next few months. The expectation for this review is for:
• A reduction of the companies' obligations related to maintenance of public telephones, which would lower capex
requirements; and
• An extension of the term the companies have to install fixed lines, which most companies find short and result in
fines if they don't meet the current 7-day limit.
However, these changes wouldn't result in lower capex levels because the regulator might require other investments,
mainly in broadband expansion.
On the other hand, we believe that the negative impact of the various regulatory measures implemented in Mexico has
already taken place in the companies' top-line growth. Although revision of the Federal Telecommunications Institute's
measures will occur in March 2016, we don't expect a significant impact on the companies' financial performance.
High competition remains. The sector faces stiff competition that could undermine their revenues and profitability, as a
result of the entry of new competitors, and development of new technologies, products, and services.
Following Mexico's telecommunications reform in 2013, AT&T Inc. completed the acquisition of Comunicaciones
Nextel Mexico de S.A. de C.V. and Iusacell for about $4.4 billion, which will cover more than 400 million consumers
and businesses in Mexico and the U.S. America Movil S.A.B. de C.V., Telefonica S.A., and AT&T currently dominate
the Mexican mobile market. In response to competition, telecom companies are launching very attractive product
offerings. For example, America Movil launched its "Sin Fronteras" plan to enable clients to call the U.S. as if they were
in Mexico. However, such initiatives may pressure the company's average revenue per unit, which would dent its
profitability in the short term.
Brazil remains a highly competitive market, due to its dominance by four large mobile players amid GDP contraction,
lower consumer confidence, and increasing unemployment levels. Nevertheless, we don't expect to see major price
wars as in the past because we believe companies wouldn't sacrifice their margins to bolster their market share.
Transportation Cyclical Credit Outlook: Stable With Negative Bias
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52. Chart 38
Rating trends for the Latin American transportation sector, consisting of railroads, vehicle and fleet leasing, airlines,
shipping, and logistics industries, are mainly stable. However, we observe rising credit pressures in several of these
sectors as local economic conditions have resulted in lower demand, high interest rates, and some increase in client
delinquency. In addition, companies exposed to currency risk have lost steam amid weaker regional currencies for the
past 12 months, and should continue to do so as exchange volatility is likely to persist.
Base-case assumptions.
We see a generally stable to slightly positive trend in the regional railroad segment. Mexican railroads are benefitting
from the country's improving economy, which pushes up demand and profitability. Meanwhile, despite Brazil's weak
economy, the domestic railroad industry's profitability remains high due to the small rail network and concentration of
cargo around commodities, mainly iron ore and grains. Contractual protective clauses should continue to offset risks of
lower volumes.
The vehicle rental and leasing industry also has a stable to slightly positive outlook, despite the bulk of rated entities in
this industry operate in Brazil only. We expect the countercyclical characteristic of the fleet rental business to mitigate
the impact of a lower demand, while adjustment clauses in contracts and hedging strategies offset the risks of higher
interest rates. Nonetheless, we expect credit metrics for the next 12 months to be fairly aligned with 2015 numbers, as
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53. growth should be more selective, reducing risks of delinquency in the portfolio of contracts. The still resilient
used-vehicle market in Brazil should maintain fairly low inventories of used vehicles and support a stable cash flow.
The shipping industry in the region will continue to confront significant challenges over the coming quarters, mainly
due to the slowdown in some economies and the excess capacity in the barge business in the Paraguay River area.
Furthermore, the platform supply vessels face reduced demand for their services and we don't expect that to improve
in the short term. Although some companies benefit from long-term contracts with minimum volume clauses, we still
have a negative outlook for the industry in 2016.
The airline industry has been hit the hardest in the region in 2015, and we don't expect improvement over the coming
quarters. The depreciation of Latin America's currencies will offset potential gains from low fuel prices. Demand in the
Spanish-speaking countries should continue to increase slightly, especially for domestic flights, which should support
marginally greater capacity. However, we expect revenues per unit to remain fairly stable. Demand in Brazil should
continue to decrease, which the contracted capacity in this market will mitigate. While the Brazilian airlines'
profitability should weaken as exposure to the dollar-denominated costs and debt will continue to take a toll.
We don't expect capex to pressure the entire industry's cash flow over the coming quarters. Most companies in the
industry (railroads, vehicle leasing, and logistics) can adjust their capex needs because they're mostly linked to growth,
which in turn depends on new contracts and volumes. The delivery schedule of vessels for the regional shipping
companies is also smooth, and most are related to barges that have short build time and can be delayed or postponed.
The airlines also have a fairly smooth delivery schedule for aircraft. And they have secured funding sources for most of
their aircraft capex, while financing for the remainder is globally available (usually financial or operating leases).
Key risks.
Further currency devaluations.Although transportation industries are domestically focused, some players—especially
airlines and shipping companies--are exposed to currency risk. We expect currency depreciation to continue posing a
risk—in the form of higher debt and costs--in the next 12 months, which could weaken metrics. However, we expect
exchange rates to be less volatile than in recent quarters. We see little risk to liquidity due to currency exchange
because most companies have solid liquidity positions.
Higher fuel prices. Companies across the transportation industry have benefited from low fuel prices over recent
quarters, but the combination of slumping demand and our expectation of rising fuel prices can hobble the airlines' and
shipping companies' performance. An increase in fuel prices is likely in 2016 (our Brent oil price deck assumes $55 per
barrel in 2016, up from an average of $50 in 2015). However, companies should be able to absorb that with minimal
impact.
Slumping Brazilian economy. We still assume Brazil's GDP growth to keep contracting in 2016, but at slower pace
than in 2015. Another lackluster year for the Brazilian economy can further undermine the value of the domestic
currency, lead to higher interest rates, and tighten credit availability for smaller companies. We believe airlines as
particularly exposed to this risk because competition in the Brazilian market has been intense and profitability is
already low. The airline industry is likely to adjust capacity over the coming quarters, but deeper reductions may be
necessary if demand continues to weaken. Also, stagnant economy imperils logistics and trucking companies because
transported volumes decrease and client delinquency spikes.
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54. Utilities Credit Outlook: Stable To Negative
Chart 39
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57. Chart 42
Our outlook is stable for the utilities sector in Latin America. However, about 10% of companies in this sector have a
negative outlook. In Brazil, where the bulk of the rated entities are based, a stalled economy constrains energy demand
while hydrology remains weak. Brazil´s hydropower-based electricity sector suffered from two consecutive years of
drought. This, along with the steep depreciation of the Brazilian real, pushed up energy costs for distributors. Also, the
foreign currency rating on the Federal Republic of Brazil (BB+/Negative/B) imposes a cap the domestic utilities'
ratings. This is based on our view of an appreciable likelihood that they would follow the sovereign in a default
scenario because we believe that their regulated status makes them vulnerable if the sovereign's credit quality weakens
significantly (i.e. potential tariff controls, revenue collection, and credit availability would suffer in such scenario).
The negative outlook on several rated Brazilian electric distributors incorporates our expectations that their EBITDA
generation and working capital will remain volatile over the next few quarters, because they will depend on the timing
of rate increases and the energy consumption trend.
Hydrology is also weak in Colombia, while new projects are coming on line in other Latin American countries, and
we're closely monitoring the proposed spin-off of Enersis S.A.'s Chilean operations. The latter is evidence of Latin
America's continued importance to international energy groups, particularly to those based in Europe. The outlook on
the water and gas utility segments is mostly stable.
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58. Base-case assumptions.
We expect the regional economy to remain a key factor for the sector´s performance. Overall, we expect low-single
digit GDP growth in the region for 2016, which should moderately raise electricity demand. However in Brazil, we
expect energy consumption to decrease about 2% in 2015.
We view the regulatory landscape as relatively stable in the region, and the companies' prudent financial policies may
help offset weaker demand. The Brazilian government has been taking initiatives aiming at restoring the sector´s
financial performance amid still weak hydrology, although the potential for liquidity mismatches exists, depending on
the timing of tariff adjustments.
Key risks.
Liquidity remains a concern in Brazil. Electricity distributors in Brazil have benefited from a series of government
initiatives to pass on higher energy costs through tariffs in 2015, after heavy reliance on government support in 2013 in
2014. But the entities we rate accumulated sizable amounts in regulatory assets. The compensation derived from these
asset accumulations are substantial when compared with the distributors' annual EBITDA, and should be passed on to
tariffs only upon each entity's annual tariff adjustments. Still high energy costs and lower consumption are hurting the
sector's liquidity, delaying the conversion of these assets into cash. Liquidity could also come under pressure from
potential debt payment acceleration in cases where there is breach of financial covenants.
Hydrology may present risks for Brazilian utilities. Brazil´s hydropower-based electricity sector suffered from
consecutive years of drought, which drained the country´s main reservoirs since the end of 2012. At the end of
November, water reservoir levels were at only 27% of capacity in the Southwest-Midwest electricity subsystem which
accounts for about 70% of the country's total reservoir capacity.
The hydrology conditions are currently better than in 2014, when the reservoir level was at 16% amid lower energy
demand. The rationing risk seems to be currently lower than it was in 2014. However, the possibility of rationing in
2016 will still depend on the hydrology during the rainy season, which lasts from November to April, and generates
around two-thirds of annual rain fall.
We also expect hydrology to be weak elsewhere in the region (particularly in Colombia and Chile) as a strong el Niño
effect is likely. Mexico is the exception, given that the majority of its power capacity is thermal.
Related Research
• Credit Conditions: Growth Will Likely Remain Weak, Though The Effect On Latin American Ratings Will Be Mixed,
Dec. 8, 2015
• Will Pressure Increase On Latin American Banks In 2016?, Nov. 18, 2015
• Latin American Structured Finance Scenario And Sensitivity Analysis 2015: The Effects Of Regional Market
Variables, Oct. 28, 2015
• Industry Report Card: For Latin American Metals And Mining Companies, Supply-Demand Imbalances Are A Prime
Concern, Oct. 14, 2015
• A Roadmap To Currency Risks In Latin America Corporates, Sept. 30, 2015
• Industry Report Card: Strong Demand And Weaker Local Currencies Will Continue To Bolster Latin America's
Forest Products Sector Amid Volatile Commodity Costs And Uncertain Global Economic Conditions, July 28, 2015
We have determined, based solely on the developments described herein, that no rating actions are currently warranted. Only a rating
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59. committee may determine a rating action and, as these developments were not viewed as material to the ratings, neither they nor this report
were reviewed by a rating committee.
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