Fitch Ratings has upgraded Cielo S.A.'s Foreign and Local Currency Long-Term Issuer Default Ratings (IDRs) to 'BB+' from 'BB' and affirmed its Long-Term National Scale Rating at 'AAA(bra)'.

At the same time, Fitch has affirmed the senior unsecured 6th debentures issued by Cielo at 'AAA(bra)'. The Rating Outlook for the corporate ratings is Stable.

The upgrade reflects the recovery of Cielo's profitability and the expectation of growing and strong operating cash flow generation. Cielo continues to benefit from its strong position in the Brazilian card payment industry and its competitive advantage relies in part on the relationship and distribution network of two important banks in the Brazilian banking system, Banco do Brasil S.A. (Foreign and Local Currency IDRs BB, Long-Term National Scale Rating AAA(bra), Outlook Stable) and Banco Bradesco S.A. (Foreign and Local Currency IDRs BB+, Long-Term National Scale Rating AAA(bra), Outlook Stable), which were upgraded following the upgrade of the Brazilian sovereign rating.

Key Rating Drivers

Highly Competitive Environment: The market dynamics for the Brazilian payment industry will continue to change quickly and Fitch expects competition to remain strong in the near term. The sector should continue to evolve rapidly, with technological innovations and new payment options, structurally changing the traditional business model. Cielo has the important challenge of quickly adapting its business model, and improving diversification in other products like financial solutions and software services.

Strong Position in the Brazilian Market: Cielo lost its position as the largest Brazilian merchant acquirer, with a reduction of market share to around 23% as of June 2023 (from 26% in 2022); the leader has around 24%. Cielo's strategy to focus on profitability recovery in detriment of Total Payment Volume (TPV) resulted in the loss of market share and Fitch expects market share to stabilize at current levels. Despite the significantly increased competition in recent years, the industry still remains concentrated, with the two largest participants still accounting for approximately 47% of the market.

TPV Growth Expected for 2024: Fitch projects Cielo's TPV to reduce in 2023 and to present growth in line with the industry in 2024 going forward. The base case scenario incorporates a TPV reduction of 7% in 2023 and growth of 6% in 2024. Cielo processed BRL594 billion in credit and debit transactions in 9M23, a 7% decrease in relation to 9M22. Fitch projects that Brazilian market TPV is expected to grow around 7% in 2024 going forward.

Stronger Operating Margins: Cielo improved its profitability, with greater penetration of small and medium merchants and of prepayment products, loss of less profitable clients, gradual improvement in product diversification, together with the greater stability of Cateno's (JV responsible for managing services related to Banco do Brasil's card business) results. Merchant E-Solutions' (MeS) divestiture in 1Q22 also had a positive impact on Cielo's operating margins, as MeS had a small contribution to the consolidated EBITDA. Fitch's base case considers an EBITDA margin between 44% and 48% in 2023-2025, compared with the average of 32% from 2019 to 2022.

Cielo is expected to generate a strong EBITDA of BRL5.0 billion in 2023, including income from acquisition of receivables, and BRL5.1 billion in 2024, compared with BRL4.8 billion generated in 2022, as per Fitch's calculations. Higher volume of pre-payment products should contribute to this growth. Cateno's contribution to Cielo's EBITDA between 35% to 40% also adds more stability to the company's cash flow generation. Fitch expects positive FCF of BRL2.0 billion for 2023 and positive BRL394 million in 2024, as Cielo's working capital needs are directly linked to the company's strategy to finance the acquisition of receivables to merchants. Base case projections incorporate average annual investments of BRL800 million and dividends around BRL600 million per year.

Low Risk of Credit Loss: Cielo has no direct credit exposure to cardholders, as the card-issuing bank guarantees cardholders' payments, while the company's exposure to merchants is limited. The company is, however, partially exposed to card-issuing bank defaults on a payment settlement for Visa and MasterCard transactions. The risk associated with Visa and MasterCard transactions is mitigated because more than 85% of the volume of transactions is concentrated in the five largest Brazilian banks, Banco do Brasil, Banco Bradesco, Itau (BB+/Stable), Caixa (BB/Stable), and Santander Brasil (not rated). For some non-investment-grade banks, Cielo's risk management policy requires the card-issuing bank to pledge collateral and/or provide SBLC (Standby Letters of Credit).

Strong Capital Structure: Cielo's net adjusted leverage, measured by the net debt to adjusted EBITDA ratio, including financial income derived from the acquisition of receivables from merchants, should be close to 2.0x in 2023 and to remain below 2.5x in the next three years. As of Dec. 31, 2022, net adjusted leverage was 2.5x.

Derivation Summary

Cielo is the second largest company in Brazil's merchant acquiring and payment processing industry, with an estimated 23% market share, after Redecard (not rated; controlled by Itau Unibanco Holding S.A.) with a 24% share. The third-largest is GetNet (not rated; controlled by Grupo Santander) with 15%.

Compared with independent players, such as Stone and PagSeguro, both with 11%, the three leaders have some competitive advantages due to their controlling shareholders' structure, as their relationship with leading commercial banks gives them access to a broad customer base to acquire merchant accounts. As is characteristic of the industry in Brazil, Cielo and its peers have no direct credit exposure to cardholders, as the card-issuing bank guarantees cardholders' payments.

Key Assumptions

Revenues of Cielo Brasil of around BRL6.4 billion in 2023 and BRL6.9 billion in 2024;

Revenues of Cateno of around BRL4.1 billion in 2023 and BRL4.3 billion in 2024;

Annual investments of approximately BRL800 million;

Dividends of 35% of net income in 2023 and 2024.

RATING SENSITIVITIES

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

A sustained improvement in profitability and market-share gains.

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

An increase in the volume of credit and debit transactions with banks rated 'BB-' and below without collateral being pledged by the card-issuing bank or not guaranteed by MasterCard;

Weakening credit profile of the main banks that operate with Cielo;

A significant loss due to fraud and chargebacks;

Tougher competition leading to a significant loss of market share and profitability;

Significant changes in regulatory risk;

A negative rating action on Brazil's sovereign ratings that leads to negative rating actions on Banco do Brasil, Bradesco, Caixa Economica Federal and Itau.

Liquidity and Debt Structure

Strong Financial Flexibility: Cielo has a strong financial flexibility. As of Sept. 30, 2023, the company reported cash and marketable securities of BRL1.1 billion and total debt was BRL13.8 billion. Cielo has around BRL5.4 billion of debt maturing in the short term, including a BRL3.4 billion private debentures due in December 2023. Cielo has strong financial flexibility to address upcoming maturities and good access to the bank and capital markets, including a sizable pool of receivables.

With the repayment of the bonds in November of 2022, the company has no debt in Foreign Currency. Total debt was composed of private debentures (24.6%), FIDC (53.5%), public debentures (21.7%) and others (0.2%).

Issuer Profile

Cielo is a multi-brand acquirer that captures, transmits, processes and settles transactions between large to small merchants with consumers under international brands such as Mastercard, Visa, Amex and local brands. Cielo is controlled by Banco do Brasil and Bradesco, with 28.65% of participation each.

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

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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