Fitch Ratings has affirmed Rede D'Or Sao Luiz S.A.'s Long-Term Foreign Currency Issuer Default Rating (LT FC IDR) at 'BB', Long-Term Local Currency IDR (LT LC IDR) at 'BBB-' and National Long-Term Rating at 'AAA(bra)'.

The Rating Outlook for the LT FC IDR is Negative, while the Outlooks for the LT LC IDR and the National LT Rating are Stable.

Rede D'Or's ratings reflect the defensive nature of its business, a solid competitive position in the fragmented hospital industry in Brazil, prominent business scale, adequate capital structure, strong liquidity and a track record of robust FCF before capex. The ratings also take into consideration the imbalance between supply and demand for hospital services in Brazil, the company's solid portfolio of counterparties and strong bargaining power.

Key Rating Drivers

Leading Business Position: Rede D'Or is the largest private hospital network in Brazil's fragmented and underserved hospital industry. The company owns 63 hospitals (10,098 beds - 8,761 operating beds) and is the administrator for another hospital as of Sept. 30, 2021. Rede D'Or has a solid business position and large scale of operations in its key markets, which serves as a key competitive advantage, allowing for lower fixed-costs and significant bargaining power with counterparties and the medical community. This scale, in addition to a strong brand, act as strong barriers to entry over the medium term.

Country Ceiling Constrain: Rede D'Or's LT FC IDR is constrained by Brazil's 'BB' Country Ceiling since its operations are domiciled in Brazil. The Negative Outlook for the FC IDR is linked to the Outlook for Brazil's sovereign rating (BB-/Negative). The investment-grade LT LC IDR reflects the resilience of Rede D'Or's business to economic downturns, and the positive prospects over the longer term.

Industry Consolidation: The recent consolidation and the increasing level of vertical integration among competitors in Brazil's hospital and clinical diagnosis industry could add to competition over the medium to long term. Business scale, strong brand and medical recognition are essential competitive advantages that help to mitigate the increasing pressure from healthcare plan providers in terms of contracts pricing. Fitch believes Rede D'Or is well positioned to face the ongoing developments in industry dynamics, but it could face more volatility to operating margins or cash flow over the medium to long term.

Strong Growth Strategy: Fitch expects Rede D'Or to continue to pursue both organic and inorganic growth opportunities with the target to add more than 5,000 beds by 2025. Fitch expects this growth to be mostly financed with equity inflow from 2020/2021. The company has an aggressive track record of acquisitions, acquiring 28 hospitals, adding 3.5k operating beds, from 2017 to September 2021. Since 2017, Rede D'Or has invested BRL6.8 billion in capex, BRL7.6 billion in acquisitions and has distributed BRL5.1 billion in dividends.

The company seeks to diversify its service portfolio by expanding its ambulatory, oncology, and advisor/consultor activities, as well as seeks opportunities to increase verticalization, i.e. the diagnostics market segment.

Adequate Margins: The company has been efficient in increasing profitability through economies of scale and in achieving synergies from acquisitions. The company has a strong track record of turning around acquired assets. Rede D'Or's net revenue grew 106% between 2017 and LTM ended Sept. 30, 2021, achieving BRL19.4 billion of revenues, while expanding operating beds by 68% to 8,800. During this period, occupancy rate ranged from 76% to 80%, while EBITDA margin fluctuated from 23%-26%. In the next three years, Fitch forecasts EBITDA margins in the 24%-26% range. Rede D'Or's operating margin is among the highest of hospital peers globally.

Manageable Pandemic Impact: Rede D'Or's operations have been temporarily affected by the coronavirus pandemic, due to the postponement of elective surgeries and lower hospital visits because of strict social-distancing requirements. Nevertheless, recovery has been solid as seen during 3Q21, when the amount of Covid-19 cases fell in the country, driven by vaccine availability. Fitch's base case incorporates that the impact of new outbreaks and variants on Rede D'Or's profitability will be manageable.

Strong Credit Metrics: Fitch projects Rede D'Or's net leverage to range from 2.1x-2.2x in 2021-2023, considering ongoing capex and/or acquisition disbursements of up to BRL5 billion per year. During 2017-2019, the average net leverage was 2.7x. Current ratings headroom incorporates that in the long term, Rede D'Or's net leverage could rise to 2.5x.

Legal Contingencies: Rede D'Or is exposed to tax litigation that could result in loss, as no provisions have been recorded. The most significant, in the amount of BRL1.1 billion, refers to allegations by the Brazilian Internal Revenue Service that certain doctors who render services in Rede D'Or's hospitals through legal entities should be considered company employees, which would require additional tax payments. Negative outcomes from this litigation could change the company's business model and affect its cost dynamics. However, Fitch has not incorporated this into its base case scenario at this time.

Derivation Summary

Rede D'Or's ratings reflect Brazil's private hospital industry's low business risk and its positive business fundamentals, adequate capital structure and strong financial flexibility. Compared to Auna S.A.A.'s

(BB-/Stable), Rede D'Or has stronger business scale and capital structure.

Rede D'Or compares well in terms of business scale and operating margins with the Brazilian non-for-profit hospital Sociedade Beneficente Israelita Brasileira Hospital Albert Einstein (Einstein; AAA(bra)/Stable), but Einstein has a track record of lower leverage.

Compared to the Brazilian diagnostic and hospital competitor Diagnostico da America S.A (Dasa; AAA(bra)/Stable), Rede D'Or has lower business risk, due to much lower competitive pressures. Both companies have aggressive growth strategies. From a financial risk perspective, currently Rede D'Or has lower leverage and greater financial flexibility following the IPO.

Rede D'Or, Auna, Einstein and Dasa all benefit from strong brands and reputation in the industry, which offer important competitive advantages and translate to strong relationships with counterparties.

On a global scale, the dynamics of the Brazilian hospital industry and regulation are not directly comparable to other countries. Rede D'Or's operating margins and financial metrics are quite sound compared with other rated hospitals within Fitch's global universe.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer Include:

Revenue growth reflecting ongoing acquisitions and greenfield/brownfields projects;

EBITDA margins of around 24%-26%;

Working capital needs to remain on historical levels;

Average Capex of BRL2 billion annually;

BRL3 billion in acquisitions disbursements per year;

A 25% minimum dividend payout.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action for the LT FC IDR is limited by Brazil's 'BB' Country ceiling;

Upward rating potential for Rede D'Or's 'BBB-' LT LC IDR is limited by its ongoing aggressive growth strategy, through both organic and M&A movements, and its lack of geographic diversification, which leads to large exposure to the local economy in Brazil.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A change in management's strategy with regard to its conservative capital structure could also lead to a downgrade, as could a deterioration in the company's reputation and market position;

EBITDA margins declining to below 20%;

Net leverage consistently above 2.5x;

Deterioration of a sound liquidity position leading to refinancing risk exposure;

Major legal contingencies that represent a disruption in the company's operations or a significant impact to its credit profile.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Rede D'Or has a track record of maintaining strong cash balances, with an average coverage of cash/short-term debt ratio of 6.4x during the last four years, and coverage of 7.1x as of Sept. 30, 2021. The company's financial flexibility is solid, and the company has shown good access to the local and cross- border capital markets.

The company had BRL24.8 billion of debt (net of derivatives and obligations with acquisitions), as of Sept. 30, 2021, of which BRL1,8 billion is due in the short term. Rede D'Or's BRL13.2 billion of cash on hand is sufficient to support debt amortization up to mid-2025. Fitch expects Rede D'Or will maintain a strong liquidity position and its proactive approach in liability management to avoid exposure to refinancing risks.

Around 33% of Rede D'Or debt, as of Sept. 30, 2021, was linked to the U.S. dollar, including USD1.7 billion senior unsecured notes due 2028/2030. The company utilizes hedging instruments to moderate currency mismatch risks, since revenues are nearly 100% originated in Brazil. Rede D'Or does not have committed credit facilities.

Issuer Profile

Rede D'Or is the largest private hospital player in Brazil, with 63 hospitals totalling 8.8 thousand operational beds as of September 30, 2021. The company has solid business positions, with ample scale differential in the states where it operates: Rio de Janeiro, Sao Paulo, Minas Gerais, Brasilia, Mato Grosso do Sul, Pernambuco, Paraiba, Bahia, Sergipe, Ceara, Maranhao, Federal District, Parana and Rio Grande do Sul.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Rede D'Or Sao Luiz S.A. has an ESG Relevance Score of '4' for Labor Relations & Practices due to labor/tax litigation. The company registers their employees (mostly physicians) as service providers, not as Rede D'Or's employees. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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