Fitch Ratings has affirmed Cementos Pacasmayo S.A.A.'s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB-'.

The Rating Outlook for the Foreign and Local Currency IDRs has been revised to Negative from Stable.

Pacasmayo's ratings reflect the company's leading business position as the main cement producer in Peru's northern region. This position has resulted in pricing power, higher margins, and is supported by its extensive logistical network. The ratings further consider the company's group structure as a subsidiary of Grupo Hochschild, financial flexibility originating from robust pre-dividend FCF and access to funding. Pacasmayo's net leverage is currently high given its business scale and investment grade level. Fitch expects net debt/EBITDA ratio to reach 3.1x by fiscal 2022 and to decline to around 2.5x by 2024.

The Negative Outlook reflects the challenges Pacasmayo faces to deleverage in the next 12 to 18 months. The current scenario of high inflation and interest rates as well as political turbulence further delaying infrastructure investments are negative headwinds that could continue to pressure cement sales further down during 2023.

Key Rating Drivers

Solid Business Position: Pacasmayo's rating is supported by its position as the primary cement producer in Peru's northern region, where it provides nearly all cement sold. The market structure has remained stable in Peru for decades, which bodes well for the credit. The company has the ability to operate with lower prices if required and still retain adequate profit margins. Further, the high costs and a long investment horizon are expected to deter competitors from entering Pacasmayo's market.

Competitive Cost Position: The company's cost position benefits from the proximity of its plants to its quarries, electrical supply contracts, purchasing the majority of its coal locally, and its capability to use natural gas. The company's competitive advantages are expected to widen in the near term, given increased clinker capacity by mid-2023. Further, Pacasmayo's competitive cost position is complemented by a favorable sales mix of bagged (90% of sales) and bulk cement (10% of sales), which results in higher average prices.

Declining Volume Trends: After the strong volume recovery noted during 2021, Pacasmayo's volume decreased 4.4% during the first nine months of 2022 mainly due to moderation in sales volume of bagged cement for self-construction, as well as decreased sales for reconstruction-related projects. Volumes should close YE 2022 at around 5% below 2021, but still higher than 2019 due to the strong rebound in demand. Home improvement demand should slowdown in 2023 considering political turbulence, less government spending and persistent high interest rates and inflation, which will likely negatively impact disposable income. The fundamentals for cement demand in Northern Peru remain favorable in the long term due to infrastructure needs, but the short- to medium-term horizon remains uncertain.

Pressures on FCF and Leverage: Pacasmayo's net leverage is expected to increase to 3.1x in 2022 and 3.0x in 2023 from 2.6x in 2021, driven primarily by higher capex disbursements with the construction of a new kiln (USD75 million) and its ongoing shareholder friendly policy. With the full operations of its new kiln during 2024 and better profitability, considering lower imported clinker, net leverage is expected to decline to around 2.5x by 2024. EBITDA should reach PEN488 million in 2022. This compares with PEN475 million in 2021, PEN313 million in 2020 and PEN403 million in 2019.

Projected leverage metrics are consistent with a 'BBB-' rating within Fitch's broader building materials universe. However, when compared to regional cement producers of approximate scale, Pacasmayo's leverage of 2.5x-3.0x is high.

Shareholder-Friendly Policies: Fitch forecasts for pre-dividend FCF is neutral in 2022, increasing to PEN166 million in 2023 and PEN292 million in 2024. These estimates assume dividend payments of around USD46 million and USD48 million in 2022 and 2023, a decline from the USD85 million paid in 2021, but still slightly above the USD41 million in 2020 and USD36 million in 2019.

Extensive Distribution Network: Pacasmayo operates a broad distribution network that is customized to the specifics of the Peruvian cement market. This provides the company with key advantages and additional barriers to entry to its market. Pacasmayo developed one of the largest independent retail distribution networks for construction materials in Peru, Distribuidora Norte Pacasmayo S.R.L. (DINO), which consists of 286 individual retailers with 413 stores under the DINO brand and accounts for over 70% of Pacasmayo's sales. This network allows the company to meet the needs of its customers across northern Peru's highly fragmented market.

Derivation Summary

Pacasmayo's 'BBB-' rating reflects its position as the primary cement producer in Peru's northern region coupled with its low-cost structure and well-developed logistical network. The small size of the cement market in the north and the logistical challenges found in this region limited the impact of imports and the probability that a global company will enter the region in the near future.

The company's rating is constrained by its lack of geographic diversification and scale of operations compared with global cement players such as CRH plc (BBB+/Stable) and Holcim Ltd. (BBB/Stable), which are considered two of the largest heavy building materials producers globally. Pacasmayo's long-term growth prospects are supported by growing demographics in Peru's Northern region, as well as Peru's infrastructure spending.

Pacasmayo's projected net leverage is higher than Holcim and CRH's net leverage at around 2.x and 1.5x, respectively. Pacasmayo's ability and willingness to maintain strong credit metrics and a conservative capital structure complement its dominant position in Northern Peru, and are crucial to the investment-grade rating, as the company lacks the geographic diversification and scale of operations of its investment-grade peers.

CEMEX, S.A.B. de C.V. (BB+/Stable) is rated lower than Pacasmayo due to their deleveraging challenging over the past years despite their larger scale of operations and more geographically diversified profiles. Cemex have strong businesses in several markets. Votorantim Cimentos S.A. (BBB-/Stable), which is also a much larger cement producer with a dominant position in Brazil and operations throughout the world, is not a direct peer, as its rating is tied to that of the Votorantim S.A. (BBB-/Stable), which includes mining and other stakes in several sectors.

Key Assumptions

Fitch's Key Assumptions Within The Rating Case for the Issuer

Consolidated cement, concrete and precast volumes sold of around 3.4MT in 2022 and 3.2MT in 2023;

Consolidated EBITDA of approximately PEN489 million in 2022 and PEN513 million in 2023;

Capex of PEN218 million in 2022 and PEN190 million in 2023;

Dividends of around PEN180 million per annum in 2022 through 2023.

RATING SENSITIVITIES

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

Materially larger scale and geographic diversification;

A record of net debt to EBITDA below 1.5x.

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

Increased competition;

Expectations of sustained net debt/EBITDA meaningfully above 2.0x;

A material reduction in CFO expectations, which is not compensated by a reduction in dividends;

Additional debt-funded dividends would be viewed negatively.

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

Demonstrated Access to Local Market Credit: Pacasmayo's liquidity has been pressured by its negative FCF generation. This should remain a weakness in the company's credit profile during 2023, and likely to improve only from 2024 on due to improved CFFO generation. Fitch believes the company benefits from enhanced financial flexibility as part of Grupo Hochschild, one of Peru's largest business groups. As of Sept. 30, 2022, Pacasmayo had cash position of PEN212 million and short-term cash of PEN638 million, as well as total debt of PEN1.4 billion.

The company has demonstrated sound funding access. On August 2021, the company entered into a PEN860 million medium-term corporate loan (Club Deal) with Banco de Credito del Peru S.A. and Scotiabank Peru S.A.A. The loan was raised to allow for the company's payment of all financial obligations with maturity until February 2023, and has been disbursed based on the maturity of each of them. Currently, the company faces the maturity of its USD132 million unsecured bonds in February 2023, and it should use its Club deal credit line to amortize it. On a proforma basis, after the payment of the bonds, Pacasmayo should have quarterly instalments of around PEN40 million.

Issuer Profile

Cementos Pacasmayo is the dominant cement company in Northern Peru and the region's only integrated cement producer. The company owns three cement plants with a production capacity of 4.9MTs.

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

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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