London: Morocco-based Zalagh Holdings has emerged as a leader in domestic commodity trader fully integrated in the animal feed industry and partially integrated in the meat production and processing industry.
Fitch in a statement said that the rating was supported by the potential for sector growth and modernisation in Morocco, where meat consumption is low compared with international standards.
Fitch Ratings has assigned Morocco-based soft commodity trader and animal feed and poultry producer Zalagh Holdings (Zalagh) a national long-term rating of B+. The outlook is stable.
However the rating is constrained by the business exposure to a single geographic market, dependence on local regulation and some vulnerability to raw materials’ price fluctuations despite Zalagh’s ability to lock in profit margins in its core segments of trading and animal feed business units, which represented 78% of reported EBITDA for 2013. We also recognise the entry of the IFC as minority shareholder in October 2013, and the related improvements in corporate governance compared with pre-2013 levels.
With a forecast Readily Marketable Inventories (RMI)-adjusted FFO gross leverage of 6.9x for 2014 (albeit expected to reduce over time), the capital structure is aggressive, reflecting Zalagh’s heavy planned investments in 2014-2016 in value-added activities. The ratings are further constrained by the debt repayment commitments at Greenlight Holding SA, an entity controlled by the Chaouni family, who control 82% of Zalagh Holdings.
Zalagh has a strong position in the agri-business in Morocco, and is unique in that it is fully integrated across the entire industry value chain. The group has relatively significant storage capacities spread throughout the country, allowing it to secure 22% of national imports of commodities. Competition is more acute in slaughtering and meat processing compared with commodity trading and animal feed; but its key competitors are not backward integrated into procurement and, hence are more exposed to raw materials and feed price volatility and sharp supply/demand imbalances in the poultry sector than Zalagh. This is, however, not sufficient to offset the small size of Zalagh in absolute terms relative to larger international peers.
The poultry market in Morocco has grown significantly over the last decade. This is a positive factor as meat producers (either internally within the group or externally) remain Zalagh’s prime client base. Yet poultry consumption per capita remains low compared with other developing countries. Growth prospects are positive as the Moroccan economy continues to expand (Fitch expects GDP growth to be 4.1% in 2014 and 4.6% in 2015), consumption shifts towards more protein-based diets and local authorities take steps to modernise the sector. However Fitch expects the supply/demand balance to remain unpredictable as production remains largely unorganised in Morocco. Also, any potential benefit from market growth is subject to local regulation changes in favour of integrated poultry producers, which are yet to be tested.
Zalagh had an EBITDAR/Gross Profit ratio (RMI-adjusted) of 56% in 2013. This level of profitability is considered strong for the rating and higher than traditional commodity traders. It is supported by Zalagh’s bias towards animal feed and other value-added categories. However, this measure is exposed to fluctuations based on capacity utilisation and the ability of management to maintain margins (that is, pricing power). In this regard we consider management’s plan to improve production efficiencies and achieve additional cost savings and economies of scale as sensible. Given the group’s restructuring efforts aimed at more harmonised operations and functions and our conservative forecasts of the impact of these efforts, we factor an RMI-adjusted EBITDA margin increasing above 7% by 2016 (2013: 6.6%).
“We expect additional top-line growth and profitability enhancement from expansion capex, particularly if regulation moves rapidly in favour of Zalagh. We note that such profitability enhancement should allow the group to start deleveraging from 2015. In our forecasts we assume Zalagh will receive around MAD180m cash VAT refund (butoir TVA) from the government next year, broadly matching next year’s capex funding needs. If this money is not received or is delayed and capex is debt-funded we estimate an RMI-adjusted FFO gross leverage of 6.2x (instead of 5.4x in our rating case). Such leverage remains commensurate with the assigned rating.
“Zalagh is considered a price taker in the international commodity markets that trade in US dollars, although it is largely price setter in animal feed domestically given its leading positions. The ability to lock in a desired margin upon feed mill producers placing their orders and low turnover ratio (average 38 days of sales in 2012 and13) are strong mitigating factors, if maintained. Transactional FX mismatch is expected to grow as Zalagh expands its feed operations domestically, but this is mitigated by its proven pass-through mechanisms, relatively stable track record of low volatility in MAD/USD exchange rate and the fact that most debt is borrowed in domestic currency.
“Zalagh has adequate liquidity in its core commodity trading and animal feed businesses. However, liquidity is considered somewhat weaker at the consolidated level, dragged by its downstream activities. Overall, the company’s Fitch-defined unrestricted cash balance of MAD18m, estimated liquid inventories and receivables (RMI) of MAD361m and undrawn revolving credit facilities (RCF) of MAD909m are just sufficient to cover short-term debt of MAD1,347m as of end December 2013. Excluding external sources of liquidity, Zalagh’s “internal” liquidity as defined in Fitch’s Commodity Processing and Trading Companies Sector Credit Factor compendium (unrestricted cash+RMI+A/R divided by total current liabilities) is rather weak, hovering between 0.5x and 0.6x.”
Fitch expects free cash flow (FCF) to remain negative in 2014 due to high capex and liquidity to remain stretched. However, capex of MAD74m in 2014 and a similar amount in 2015 are scalable, introducing some flexibility in FCF. The rating also reflects Zalagh’s limited financial flexibility; however Zalagh may be contemplating accessing the domestic bond market to diversify its funding sources and finance growth capex, which would help support its rating.
Debt borrowed at Greenlight Holding to acquire Zalagh’s own shares as part of the 2011 buyout creates, in our view, some pressure on Zalagh to upstream cash by way of dividends to service such indebtedness, even though such debt does not feature any cross-default with Zalagh’s own indebtedness. This is balanced by the Chaouni family shareholders’ commitment to allocate their own share of dividends received, if necessary, to accelerate Greenlight’s debt repayment. As such we expect RMI- adjusted FFO fixed charge cover (adjusted for the share of dividends paid by Zalagh used to service debt at Greenlight) of 1.4x for 2014 to rise to 1.7x in 2015 in line with the assigned rating.
“The rating factors in the support from IFC (a member of the World Bank) as a recent new shareholder in Zalagh. The rating also reflects its strengthened senior management team following the September 2011 buyout, the reinforced business functions, including IT, and executive sub-committees put in place together with the appointment of two independent directors to the board. In addition management controls have been tightened. Zalagh’s limited disclosure is considered a weakness relative to listed companies, although it is in line with its privately held status.