Research Update: NH Hotel Group Outlook Revised To ...

1 Research Update: NH Hotel Group Outlook Revised ToPositive On Expected Debt ReductionAnd Sound Cash Flow Generation;Ratings AffirmedPrimary Credit Analyst:Natalia Arrizabalaga, London + 442071763289; Contact:Natalia Goncharova, London + 44(0)2071763018; Of ContentsOverviewRating ActionRationaleOutlookRatings Score SnapshotIssue Ratings--Recovery AnalysisRelated CriteriaRatings 23, 2018 1 Research Update: NH Hotel Group Outlook Revised To Positive OnExpected Debt Reduction And Sound Cash FlowGeneration; Ratings AffirmedOverview Spain-based NH Hotel Group (NH) recently reported EBITDA of 233million and reported EBITDA margin for financial year (FY) solid performance, together with the full repayment of the 100million notes due 2019, has led us to adjust leverage to as weexpected.

2 The potential conversion into equity of the 250 million bond dueNovember 2018 and our expectation that its strong EBITDA growth maycontinue results in our adjusted leverage moving below in the next18 months. We are therefore revising the Outlook on NH to positive from stable andaffirming our 'B' issuer credit rating. At the same time, we areaffirming our 'BB-' issue-level rating on NH's senior secured notes. The positive Outlook reflects the potential for an upgrade if NH cangenerate meaningful positive free operating cash flow (FOCF) over thenext 18 months and reduces its debt by converting its 250 million bondinto ActionOn March 23, 2018, S&P Global Ratings Revised its Outlook on Spain-based NHHotel Group (NH) to positive from stable.

3 At the same time, we affirmedthe 'B' issuer credit also affirmed our 'BB-' issue ratings on the Group 's 400 million seniorsecured notes. The recovery rating is '1', indicating our expectation of veryhigh (90%-100%; rounded estimate: 95%) recovery prospects in the event of apayment Outlook revision reflects the possibility that if NH reduces its debt byconverting its 250 million bond into equity and generates meaningful FOCF inthe next 18 months, we could upgrade the understand that the bond conversion into equity by November 2018 is 23, 2018 2likely, considering that its share price ( as of March 19, 2018) iscurrently trading comfortably above the conversion price ( per share). Ifthese notes were converted, and all other factors stayed the same, we estimatethat NH's reported gross debt would decrease from around 740 million to 490million or reported gross leverage (about on an S&P GlobalRatings-adjusted basis).

4 NH demonstrated solid operating performance in FY2017 with revenue growthmainly driven by its Spanish operations, despite the political disruptions inCatalonia as well as in Benelux; the latter is recovering strongly after thenegative impact of the terrorist attacks in 2016. Reported EBITDA marginimproved to , from in 2016, thanks to NH's successful repositioningplan, which saw its average daily rate (ADR) increase, and efficiency measuresimplemented during the year. NH also generated strong positive FOCF in 2017after five consecutive years of negative FOCF. In addition, the company repaidits 100 million high-yield bond due 2019, which resulted in year-end adjusteddebt to EBITDA of compared to as of December 2016 and funds fromoperations (FFO) to debt of around ( as of December 2016).

5 For FY2018, we anticipate NH will benefit from positive trends in the travelindustry, boosted by supportive macroeconomic environments in its keyoperating markets (Spain, Benelux, Germany, and italy ) and by gainingpenetration mainly in Benelux and Central Europe and to a lesser extent inSpain and italy . In our view, the above-mentioned bond conversion andfavorable trading Outlook in 2018, barring any unforeseen events, could leadto our adjusted debt to EBITDA moving close to over the next 12 also believe that the company will likely keep generating positive reportedFOCF, except for non-recurring capex in connection with the Hotel in New York(around 46 million). That said, we expect NH to be able to generate positiveFOCF from 2019 note news of possible changes in the Group 's shareholder structure.

6 Wewould assess, if and when necessary, any potential change in NH's ownershipstructure that may affect its financial policy, for example if any privateequity Group (or a combination of private equity groups) gained 40% of itsequity, which would lead us to assess the company as financial-sponsor-ownedunder our 's competitive position reflects solid brand recognition and relatively highbarriers to entry given that many of its properties are located in prime realestate markets. Despite still relying heavily on owned or leased hotels (about75% of total rooms)--which in our opinion contributes to a high and relativelyinflexible fixed-cost base and greater constraints on the Group 's earnings ina cyclical downturn--we note that NH is moving toward a more asset-lightbusiness model.

7 It is doing this by focusing on growth through managementcontracts and more-flexible rent-leasing agreements, instead of fixed rentagreements, as well as exiting loss-making lease contracts. Additionally, weacknowledge the cost initiatives undertaken by the company across differentbusiness levels, which led to 11 million cost savings in 2017 and which weestimate will create an additional 5 million savings for 2018, are 23, 2018 3 Research Update: NH Hotel Group Outlook Revised To Positive On Expected Debt Reduction And Sound CashFlow Generation; Ratings Affirmedin a higher profitability our view, NH's business remains constrained by its limited geographicalconcentration in Europe (about 90% of total revenues) as well as its limitedformat diversification with a still significant reliance on mid-scale hotels,where NH currently has a strong position.

8 Its strategy to continue increasingits presence in the upper-scale category should contribute to higher revenueper available room (RevPAR) and therefore improve assessment factors in some key business risks, including: High profit volatility over the lodging cycle given the high fixed costbase of its owned hotels; The cyclical, fragmented and competitive nature of the lodging industry;and Exposure to discretionary consumer spending. We also think that the growing Airbnb market could weigh on NH, althoughwe recognize that NH's proposition is different and targets more affluentcustomers, who are often on business trips and needing a shorter base case assumes: GDP growth expectations in NH's main countries of operations--Spain(2%-3%), italy (about 1%), The Netherlands (about 2%), Belgium (1%-2%)and Germany (1%-2%)--should support Group revenue growth over the nexttwo years.

9 A strong Outlook for the lodging industry, from which NH is well-placedto benefit. RevPAR increases in the low-to-mid single digits in 2018, slowing down in2019. Revenue growth of about 4%-5% for the next two years coming frompenetration mainly in Benelux and Central Europe where we believe thereis still room for additional supply. Reported EBITDA margin expected to grow to over 15% by FY2018 and closeto 16% by FY2019 thanks to cost efficiency measures. Our assumption issupported by the current trend, with the EBITDA margin already increasingto in FY2017 from in FY2016. Capex of about 180 million in 2018 (including 46 million investment inthe New York Hotel refurbishment), which we understand will be funded byavailable cash.

10 For 2019 and onward, we expect capex of around 100million- 115 million, out of which around 65 million would bemaintenance capex. Progressively increasing shareholder distributions over the followingyears with a dividend payout policy of about 50% of net recurring income. We assume a 250 million bond conversion in November 2018, as thecompany's current share price is well above the conversion price 23, 2018 4 Research Update: NH Hotel Group Outlook Revised To Positive On Expected Debt Reduction And Sound CashFlow Generation; Ratings Affirmed on these assumptions, we arrive at the following credit measures: Adjusted debt to EBITDA of in 2018, decreasing steadily to 2020. Adjusted FFO to debt of 10%-12% over the next three years.