DBRS Morningstar Confirms Elis S.A.’s BBB (low) Issuer Rating

DBRS Ratings Limited (DBRS Morningstar) confirmed the BBB (low) Issuer Rating of Elis S.A. (Elis or the Company). The trend remains Stable. The rating confirmation reflects, despite the significant challenges the Coronavirus Disease (COVID-19) is posing, Elis’ continued industry-leading position, strong brand name recognition, and efficient and large-scale operations. DBRS Morningstar expects Elis' credit metrics to deteriorate and be lower positioned for the rating category, as a direct consequence of the coronavirus-related disruptions. DBRS Morningstar's current expectation is that Elis, by taking a number of precautionary measures aimed at preserving earnings, cash flows and liquidity, will maintain credit metrics necessary to avoid a negative rating action. While Elis’ hospitality segment is by far the most heavily affected, the Company’s diversification in terms of its customer base and end-markets, without necessarily fully compensating for the lost revenues, continues to provide some level of support and visibility. The rating is also supported, in a normal business environment, by the long-term nature of the contracts and high renewal rates leading to strong revenue visibility, and the expectation that the Company’s surplus cash flow generation will be used towards deleveraging. However, the rating is constrained by the Company’s exposure to markets that have limited organic growth prospects or are being hit hard by coronavirus, such as the hospitality sector, and the high capital intensity of its business model, which could all potentially limit earnings and cash flow growth and therefore deleveraging.

Elis benefits from its industry-leading position and strong brand name recognition in the flat linen, workwear, hygiene, and well-being service markets. As such, the Company has developed efficient operations with solid economies of scale, creating strong pricing power. The Company benefits from a dense network in its French core market, which supports efficient operations and deliveries to customers, and, following acquisitions over the past few years, it has replicated its French model in other countries. Beyond its primary markets, Elis has been actively growing its footprint in Europe and Latin America through both organic growth and acquisitions with several smaller bolt-on acquisitions as well as larger and transformative ones, such as Berendsen in September 2017, which added about EUR 1.3 billion in annual revenues. Elis’ acquisition strategy does not currently affect the rating, but if it were to undertake heavily debt-funded acquisitions and/or be less successful integrating such acquisitions, this could negatively affect the rating. In addition, the Company has shown resiliency through market downturns and was able to maintain stable margins during the 2008–09 crisis, which have remained consistently above 30% on an EBITDA basis since 2001. Elis’ revenue visibility and margins consistency are supported by its long-term contracts (four years on average), close to 400,000 customers with limited concentration, high customer retention rates, and a variable cost structure in particular, which will help deal with the disruptions caused by coronavirus. The Company is fairly diversified by the type of services it offers and customers it serves, insulating it from cyclicality or volatility in any one particular sector. The Company also benefits from the fact that it provides an essential service to its customers, which often represents a relatively small portion of their costs base, allowing Elis to pass on increased costs. Also, many of Elis’ customers are small and do not have strong price negotiating power, a positive for the Company.

The rating also takes into consideration the limited organic growth prospects in mature markets such as Western Europe, particularly France, its largest single market. However, the Company’s acquisition strategy has mitigated its reliance on the French market, which currently contributes about one-third of its revenue, down from about 70% in 2014. Furthermore, the flat linen business line, because of replacement requirements, demands high maintenance capital expenditures, which, while variable to a certain extent, can potentially limit cash available for debt repayment in a market slowdown. While DBRS Morningstar understands that Elis’ acquisition strategy is on pause while it deals with the far-reaching effects of the coronavirus-related disruptions, in a normal business environment, it can use cash that can potentially limit deleveraging opportunities while also posing a potential integration risk. Despite the significant reduction in variable costs as well as capital expenditures, it is now unclear how much free cash flow Elis will be able to generate in 2020.

While in 2020 Elis’ financial risk profile will deteriorate and put downward pressure on the rating, DBRS Morningstar expects that once the coronavirus-related disruptions subside, the Company’s financial metrics will return toward what is considered consistent with a low investment grade rating such as DBRS Morningstar-adjusted debt-to-EBITDA trending towards 3.5 times and DBRS Morningstar-adjusted cash-flow-to-debt trending towards 25%. The strong business risk profile, expectation of free cash flow surpluses, and the recent efforts and commitment from management to reduce leverage by actively repaying debt and shifting towards a more conservative financial policy give DBRS Morningstar comfort that these credit metrics are tenable on a sustainable basis. However, if the effects of coronavirus are further reaching and/or last much longer than currently expected and lead to a significant slowdown or reduction in earnings, smaller-than-anticipated free cash flow generation, and higher leverage for an extended period of time, DBRS Morningstar could consider a negative rating action. In addition, a return to more aggressive financial policies or debt funding large acquisitions could also lead DBRS Morningstar to take a negative rating action. While unlikely in the near term, the rating could be upgraded if the Company significantly improved its operating performance and its financial metrics on a sustained basis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883/.

Notes:
All figures are in euros unless otherwise noted.

The principal applicable methodology is the “Rating Companies in the Services Industry” methodology (February 2020). Other applicable methodologies include the DBRS Morningstar Criteria “Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationship” (November 2019). These can be found at: http://www.dbrsmorningstar.com/about/methodologies.

The primary sources of information used for this rating include Elis’ financial reports, company presentations, and meetings and discussions with Elis’ management. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and U.S. regulations only.

Lead Analyst: Valentino Teobaldo Daprile, Senior Vice President
Rating Committee Chair: Charles Halam-Andres, Managing Director
Initial Rating Date: 28 March 2019
Last Rating Date: 28 March 2019

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The rating methodologies used in the analysis of this transaction are listed below and can be found at: http://www.dbrsmorningstar.com/about/methodologies.

--Rating Companies in the Services Industry (5 February 2020)
https://www.dbrsmorningstar.com/research/356435/rating-companies-in-the-services-industry
--Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationship (25 November 2019) https://www.dbrsmorningstar.com/research/353260/dbrs-morningstar-criteria-rating-corporate-holding-companies-and-parentsubsidiary-rating-relationships

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com.