OREANDA-NEWS. S&P Global Ratings today affirmed its 'BB' long-term corporate credit rating on France-based textile and appliances rental provider Elis S. A. The outlook is positive.

At the same time, we affirmed our 'BB' issue rating on Elis' €800 million senior notes, and €850 million of senior facilities due February 2020. The recovery rating on the notes is unchanged at '3', indicating that our recovery expectations are in the higher half of the 50%-70% range.

The affirmation reflects that we continue to believe that Elis' credit metrics may improve such that they support a higher rating, even though the company has announced two acquisitions with a combined enterprise value of €510 million, which we expect will temporarily increase its debt leverage.

On Dec. 21, 2016, Elis announced its intention to acquire Spain-based Indusal and Brazil-based Lavebras, two direct competitors within the textile and appliance rental market. To fund the acquisition, Elis had signed a €550 million bridge facility. We understand €225 million of this will be taken out by debt and the remaining €325 million will be financed with a planned rights issue.

In conjunction with the planned acquisitions, Elis had also announced that it intends to refinance its €850 million senior facilities maturing in 2019 with €1.15 billion of senior facilities maturing in 2022. We understand that Elis closed the acquisition of Indusal on the signing date, but that the Lavebras acquisition is still subject to regulatory approval and other customary closing conditions.

Indusal and Lavebras both hold leading market positions in their local markets, and we expect that if the acquisitions go ahead as planned in the next couple of months, the combined operations will allow Elis to considerably strengthen its local presence in the markets, which is in line with Elis' stated strategy of contemplating acquisitions to achieve market leadership. This is particularly important in an industry where network density can be a key competitive advantage as it enables companies to take on large-scale projects and allows more efficient operations due to shorter transfer periods. We also note positively that the two acquisitions continue to lessen Elis' dependency on its domestic French market. Nevertheless, we note that pro forma for the contemplated transactions, Elis' revenue generation in France remains significantly above 50%, which we consider as a constraint for the business risk profile in particular given our relatively sluggish economic growth expectations for the French economy.

Our aggressive financial risk profile assessment reflects our view that Elis will generate funds from operations (FFO) to debt of about 20% and debt to EBITDA of 4.0x-4.5x in 2016, improving to above 20% and 3.5x-4.0x in 2017, respectively. We also take into account the group's comparatively weaker free operating cash flow to debt metrics, which we estimate at about 5% in 2016, improving to about 6%-7% in 2017. Elis' free operating cash flow (FOCF) is held back by the relatively high level of capital expenditures (capex; 18% on average over the past three years) compared with peers in the wider business and consumer services sector. We, therefore, would likely need to see stronger operating performance than we currently expect, coupled with disciplined financial policies, to see FOCF to debt increase to about 10%, a level that would be consistent with a 'BB+' rating. We also see certain execution risks related to the planned capital increase, which could hinder the group's ability to improve its credit metrics in the short term.

The positive outlook reflects our view that Elis will be able to maintain its steady organic growth along with broadly stable operating margins to reduce leverage following the two acquisitions. We see potential for strengthening credit metrics that would support a higher rating. In our view, this hinges on a continued strong operating performance, smooth integration of the two acquisitions, well-controlled investments, and successful placement of the rights issue.

We could consider an upgrade in the next 12 months if the group integrates recent acquisitions smoothly, improves its margins in those geographies faster than we anticipate, and maintains disciplined financial policies and contained investments, which could allow Elis to generate stronger FOCF than we currently forecast. We consider FOCF to debt of about 10% and FFO to debt comfortably above 20% to be commensurate with a higher rating.

We could take a negative rating action if we observe acceleration of litigation affecting the Brazilian entities, significantly harming the company's brand and leading to the loss of key contracts and deterioration in credit metrics, with FFO to debt dropping to 10%-12%. A more aggressive financial policy, translating into adjusted debt to EBITDA moving toward 5x, could also lead us to consider a downgrade.