Fitch affirms Hypermarcas' issuer default ratings at BB, revises outlook to negative

Michelle Rivera

RIO DE JANEIRO, Brazil , December 20, 2011 (press release) – Fitch Ratings has affirmed the following ratings of Hypermarcas S.A.'s (Hypermarcas):

--Long-term foreign currency Issuer Default Rating (IDR) at 'BB';

--Long-term local currency IDR at 'BB';

--Long-term national scale rating at 'A+(bra)';

--Senior unsecured notes due in 2021 at 'BB';

--Third debentures issuance at 'A+(bra)'.

The Rating Outlook was revised to Negative.

The Outlook revision reflects Fitch's concerns about Hypermarcas' ability to recover its EBITDA generation and to deleverage during 2012. The ratings are currently under pressure due to the company's weak operating results, high leverage levels, and execution risks related to the integration of several past acquisitions. The company's ability to restore sales and improve profitability and EBITDA generation during 2012 will be key to avoiding rating downgrade.

The 'BB' and 'A+(bra)' ratings reflect Hypermarcas' leading position in the competitive Brazilian consumer products sector, the strength of its brands, the diversification of its product mix, and the resilience of the pharmaceutical and personal care industries to economic conditions. Hypermarcas' management's commitment to maintain a strong liquidity position is key to sustaining the ratings in the short term. The strategy of selling non-complementary businesses combined with the decision to slow its aggressive growth plans via acquisitions are viewed positively and are further incorporated into the ratings.

Strong Business Position, Diversified Product Portfolio:

Hypermarcas has one of the largest and most diversified consumer products brand portfolios in Brazil, with focus on the pharmaceutical, beauty and personal care segments. The significant expansion of Hypermarcas operations and product portfolio in recent years reflects its aggressive expansion profile via acquisitions. Since 2007, Hypermarcas carried out 23 acquisitions, which totaled around BRL8.1 billion. The company' business strategy is to capture synergies through the integration of acquired operations into a single cost platform in terms of packing, distribution, advertising and marketing.

2011 Financial Results Pressured Credit Quality:

Changes in the commercial strategy and many integration fronts have deteriorated Hypermarcas' operating cash flow generation, measured by EBITDA, during the past year. The company has implemented new commercial policies seeking to balance sell in and sell out sales levels. Hypermarcas has reduced financial terms with wholesalers, which have resulted in a destocking process in the distribution chain and a reduction in sales. Since the major part of the destocking process occurred in the high-value pharma products, it also pressured the company sales mix and cost structure. At the same time, operating margins were further pressured by increased sales expenses due to the integration of sales forces and restructuring efforts. Going forward, the company has the challenge of recovering sales, while getting synergies from past acquisitions.

Challenge to Generate Free Cash Flow to Support Deleverage

During the last 12 months (LTM) ended on Sept. 30, 2011 Hypermarcas' adjusted EBITDA was BRL794 million, which compares to a pro forma EBITDA of BRL920 million during 2010, considering 12 month results for past acquisitions. EBITDA margins for the period were 22% and 25%, respectively. During the LTM, Hypermarcas recorded negative free cash flow of BRL26 million as a result of higher capex for expansion (BRL180 million) and dividends (BRL87 million). The company'srisk of breeching a debt covenant is low until December 2012.

High Leverage

Hypermarcas' leverage is high and is not consistent with its current ratings in the medium term. The recent announcement of the divestiture of its home and food assets (BRL445 million) enhances Hypermarcas' cash position, but it is not sufficient to materially change its currently high financial leverage. On a pro forma basis, Hypermarcas net leverage ratio, measured by net debt/EBITDA, would reduce to 3.5 times (x) from the 4.1x reported during the LTM. Fitch expects some pressure on Hypermarcas' fourth quarter 2011 (4Q'11) EBITDA, which should result in net leverage ending 2011 at about 3.8x.

Strong Liquidity is Key

Fitch views Hypermarcas' refinancing risk as manageable at this time. As of Sept. 30, 2011, the company's cash position of BRL2.5 billion was sufficient to support debt amortization through the end of 2013 (BRL2.1 billion). Hypermarcas' total debt grew to BRL5.8 billion in 2011 from BRL 4.2 billion in 2010. Its debt was mainly comprised by local debentures (BRL2.6 billion or 45% of total debt), international bonds (BRL1.4 billion or 24%) and seller financing (BRL1.1 billion or 20%).

KEY RATING DRIVERS

Rating downgrades would likely to be driven by the company's inability to recover its operating cash flow generation and to effectively sustain a deleverage process and/or deterioration in its liquidity position.

Additional information is available at ' www.fitchratings.com '. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

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