Potential ‘fallen angels’ show impact of Brazil slowdown

http://www.ft.com/cms/s/0/d5af17dc-f3de-11e4-99de-00144feab7de.html#ixzz3ZP86s1bW

May 6, 2015 4:29 pm

Potential ‘fallen angels’ show impact of Brazil slowdown

Jonathan Wheatley/FT

Companies face junk credit rating downgrade amid corruption scandal

©Getty

Brazil’s potential fallen angels illustrate the economy’s fall from grace

A darkening gloom hangs over Brazil’s economy. Analysts are steadily downgrading their growth projections for the economy this year, while inflation expectations creep ever upwards.

As evidence that the strain is being felt by businesses, a report from Moody’s Investors Service shows Brazil overtaking Russia as home to the emerging world’s largest number of potential “fallen angels” — companies at risk of losing their investment grade credit rating and falling into speculative grade, or junk.

The central bank’s latest weekly survey of market economists shows Brazil’s gross domestic product shrinking 1.18 per cent this year and consumer prices rising 8.26 per cent.

Consumer and business confidence is lower than even at the depths of the global financial crisis of 2008-09.

A multibillion dollar corruption scandal at Petrobrás, the government-controlled oil company, threatens to contaminate business life and the government faces an increasingly unhelpful Congress as it struggles to balance its books using recessionary measures in mid recession.

Hanging over the economy is the threat of electricity rationing, an issue that all but brought down a previous government in 2002.

The threat has been averted for now by renewed rainfall after a drought — most of Brazil’s generation comes from hydroelectric plants — but it will resurface if, as expected, the economy picks up in the fourth quarter of 2015, just as water levels in the country’s reservoirs are likely to be at renewed lows.

Rationing of an indirect sort is already in place: electricity prices for many consumers have risen more than 40 per cent this year as the government cut subsidies and turned on more expensive thermal plants to make up for lost hydro power. Consumers are cutting back.

So it is unsurprising that the biggest group of new potential fallen angels in Moody’s latest quarterly review of its “Crossover Zone” consists of Brazilian electricity utilities.

Moody’s classifies as potential fallen angels any companies rated Baa3, its lowest investment grade, with a negative outlook or on review for downgrade.

Its Crossover Zone also includes potential rising stars: those rated Ba1, its highest speculative grade, with a positive outlook or on review for upgrade.

Into the Crossover Zone: new potential fallen angels, Q1 2015
Company and country	Sector	Rationale
AES Tiete ., Brazil	Electric utility	Weaker than expected financial performance in 2014 due to its eventual exposure to the spot market coupled with the maintenance of an aggressive dividend payout that has led to a deterioration in liquidity
Bandeirante Energia ., Brazil	Electric utility	Growing uncertainties about the potential impact of any energy rationing on the company’s cash flow and liquidity. Lack of clarity on how the company will handle the distribution of dividends in light of an expected deterioration in cash flow metrics despite the recent mandated increase in tariffs as well as the scheduled fourth tariff review in October 2015
Espirito Santo Centrais Eletricas — Escelsa, Brazil	Electric utility	Moody’s expects that Escelsa’s credit metrics will weaken and its liquidity position will become stressed in comparison with 2014 when the company’s funds from operations were overstated by an estimated R$100m from the recognition of regulated assets pertaining to previous periods, following new accounting IFRS procedures.
Energest, Brazil	Electric utility	Growing uncertainties about the potential impact of any energy rationing or higher exposure to the spot market on the company’s cash flow. Potential increase in its dividend payout ratio to meet the cash needs of its holding company
Golden Eagle Retail Group, China	Retail	Moody’s fears that Golden Eagle’s acquisition of a property project in Suzhou will raise its financial leverage. Increase in business and execution risks
L-3 Communications , US	Aerospace and national security	Weaker than expected credit metrics, reduced scale and a lower amount of earnings retained than the Baa3 rating had anticipated
Construtora Norberto Odebrecht , Brazil	Engineering and building	Deterioration in the industry fundamentals for engineering and construction in Brazil on the back of corruption scandals at Petrobrás and increased macroeconomic uncertainties
Rexam , UK	Packaging	Ball Corporation’s announced proposal to take over Rexam, which will probably result in a speculative grade financing structure of the combined group
Verisk Analytics US	Data analytics and risk assessment	Moody’s concern that the company will be operating at a significantly higher leverage level at a time when it is integrating a rather large acquisition of Wood Mackenzie
Weatherford International , US	Oil and gas services	Risk that debt balances could increase during the cyclical downturn, weakening the company’s financial leverage profile relative to a number of its Baa3 rated peers
Source: Moody’s, EM Squared

Brazil’s five new potential fallen angels, see chart above, join three other Brazilian companies already in the Crossover Zone at risk of downgrade: Eletrobrás, the country’s biggest power generator and transmitter; Braskem, a petrochemicals company; and Sabesp, the São Paulo state water utility.

In its report, Moody’s singles out Brazil for broader concern. “We downgraded 10 Brazilian corporates in the first quarter of 2015,” it notes, “as compared to no upgrades. Corruption allegations and the consequent tighter liquidity . . . were directly and indirectly responsible for five downgrades. The balance were related to lower commodity prices and company specific operating challenges amid a worsening economy, rising inflation, corruption scandals, growing unrest, and even the threats of water and energy rationing. There are nine issuers with negative outlooks, which could result in further downgrades over the next 12-18 months.”

There is consolation of a sort for Brazil: it only outranks Russia in the Moody’s Crossover Zone because 18 Russian companies fell out of it during the quarter and went deeper into junk, all related to the downgrade of Russia’s sovereign rating.

But that will be cold comfort. As Moody’s notes, the outlook for many Brazilian companies in 2015 is increasingly uncertain.

Copyright The Financial Times Limited 2015.