Fitch Ratings-New York-31 March 2017: Fitch Ratings has assigned an expected rating of ‘B+(EXP)/RR4’ to LATAM Airlines Group S.A.’s (LATAM) proposed unsecured notes to be issued through its fully owned subsidiary LATAM Finance Limited. The notes will be fully guaranteed by LATAM. The target amount for the proposed transaction is in the USD500 million to USD750 million range. The total amount and tenor for the proposed issuance will depend on market conditions. Proceeds from the proposed issuance are expected to be used primarily to refinance debt and for general corporate purposes.

Fitch currently rates LATAM’s Long-Term Issuer Default Rating (IDR) ‘B+’ with a Stable Outlook. A full list of LATAM’s ratings follows the end of this press release.

LATAM’s ratings and Stable Outlook reflect expectations that improvement in the company’s credit metrics will continue during 2017. The company reached improvement in liquidity and significant reduction in fleet commitments in 2017-2018. During 2017, the company’s EBIT margin is expected to reach 6.5%, adjusted gross leverage 5.5x, and liquidity (measured as cash and unused committed credit lines/latest 12 months [LTM] revenues ratio) should remain near 18%.

LATAM’s ratings are supported by its diversified business model, important regional market position, and adequate liquidity. These positive factors are tempered by the company’s still high gross adjusted leverage and operational volatility related to some key markets. The ratings of LATAM and TAM and their subsidiaries take into account the credit linkage between the two companies, which stems from their operational, strategic, and legal ties. These links are reflected in the existence of cross-guarantee and cross-default clauses related to the financing of aircraft acquisitions for both LATAM and TAM.

KEY RATING DRIVERS

Moderate Traffic Growth

Fitch expects the company’s consolidated boarded passengers to reach an annual growth rate in the 3% to 4% range during 2017. This view incorporates the expectation that traffic trends for the Spanish Speaking Countries (SSC) and International segments will continue performing well, while traffic levels for the Brazilian segment will stabilize in 2017. Declining yields have been one of the key factors affecting LATAM’s total revenues and operational margin during 2015-2016. Fitch expects the company’s average passenger yields to remain relatively stable during 2017 driven by a better operating environment, particularly in the Brazilian segment.

EBIT Margin Projected at 6.5%

LATAM plans capacity increases in 2017 of 0%-2% in the international segment and 4%-6% in the SSC segment, along with a planned capacity decrease at -2%-0% in the Brazilian domestic segment. The cargo segment should see a contraction in the range of -10%/-12%. Under its base case, Fitch expects LATAM’s 2017 total revenues to be approximately USD10.1 billion, representing a 6% increase over 2016, compensating for some increase in fuel cost and resulting in an EBIT margin of 6.5% in 2017.

Better Fundamentals in the Brazilian Market

Expected trends in traffic and passenger yields should result in better operational margins for the Brazilian market in 2017. Industry capacity reductions, executed through 2016, should drive a recovery in passenger yields while the improvement in Brazil’s macroeconomic conditions is anticipated to drive moderate traffic growth in 2017. Fitch forecasts Brazil’s GDP growth to be 0.7% in 2017, an improvement from the contraction of 3.5% in 2016.

Slow Deleveraging

LATAM’s gross adjusted leverage was 6x in December 2016, a moderate improvement from 6.5x in 2015. Fitch’s base case envisions the company’s gross leverage trending to 5.5x by year-end 2017. LATAM’s adjusted gross leverage, measured as total adjusted debt/EBITDAR, was 6x at Dec. 31, 2016. The company’s total adjusted debt was USD12.6 billion at Dec. 31, 2016. This debt includes USD8.6 billion of on-balance-sheet debt and USD3.9 billion of off-balance-sheet obligations related to operating leases with combined rental payments of approximately USD570 million in 2016.

Positive Free Cash Flow (FCF) in 2017

Fitch views the company’s on-going capex reduction as positive for its FCF generation. LATAM maintains a total capex plan that calls for capex levels of USD487 million and USD982 million during 2017 and 2018, respectively, which represents a material reduction when compared with the company’s historical capex levels. Fitch expects LATAM’s FCF margin to be positive during 2017-2018 driven by revenue growth, continued EBIT margin improvement, and low capex levels relative to historical 2014-2015 levels. The company’s 2017 FCF generation is estimated in the USD500 million to USD700 million range, representing a 5% to 7% FCF margin, respectively. Fitch’s base case assumes the company’s gross on-balance-sheet debt will decline to about USD8 billion by year-end 2017.

Strong Credit Linkage

LATAM maintains indirectly all of the economic rights and 49% of the voting rights in TAM, which is an affiliate company of LATAM. The ratings of LATAM and TAM also incorporate the strong credit linkage between both entities with significant legal, operational and strategic ties existing between the two companies. In addition, the financing of the combined fleet plan capex is implemented through LATAM, with the new aircraft being subleased to TAM. Furthermore, the view of strong legal ties existing between LATAM and TAM is supported by cross default clauses incorporated in LATAM’s USD500 million unsecured notes due in 2020.

KEY ASSUMPTIONS

Fitch’s key assumptions within the rating case for LATAM include:

—2017 net revenues to increase 6%;
—2017 EBIT margin 6.5%;
—2017 gross adjusted leverage, measured as total adjusted debt to EBITDAR, of 5.5x;
—2017 coverage ratio, EBITDAR/(net interest expense plus rents), 2.4x;
—2017 Liquidity (measured as readily available cash plus unused committed credit facilities over LTM net revenues), 18%;
—2017 FCF generation positive in the USD500 million to USD700 million range.

RATING SENSITIVITIES

Positive Rating Action:

Considerations that could lead to a positive rating action (rating or Outlook) include liquidity, measured as cash/LTM revenues, consistently above 15%; gross adjusted leverage consistently approximately 4.5x; neutral-to-positive FCF generation; coverage ratio, measured as the total EBITDAR/(net interest expense plus rents) consistently above 2.5x; and EBIT margin moving to 8%.

Negative Rating Actions:

Considerations that could lead to a negative rating action (rating or Outlook) include sustained negative FCF; liquidity, measured as cash/LTM revenues, consistently below 10%; gross adjusted leverage consistently above 5.5x; EBIT margin consistently below 6.5%; and coverage ratio, measured as total EBITDAR/(interest expense plus rents), consistently below 2.25×.

LIQUIDITY

Adequate Liquidity, Cash plus Revolving at 18% of Revenues

Fitch views the company’s liquidity position as adequate for the rating category. LATAM recently completed the capital injection from Qatar Airways (QA) in exchange for 10% of the airline’s total shares. LATAM held cash of USD1.4 billion as of Sept. 30, 2016, compared with short-term debt of USD1.8 billion. The USD608 million capital injection occurred during fourth-quarter 2016. LATAM’s liquidity is expected to remain approximately USD1.5 billion during 2017-2018.

Since December 2016, LATAM has in place a senior secured revolving credit facility (RCF) of approximately USD325 million. The RCF is collateralized by a combination of aircraft, spare engines and spare parts. Including the RCF, the company’s level of liquidity, measured as total cash and marketable securities plus unused committed credit lines over LTM revenues, is expected to be around 18% during 2017.

LATAM faces debt amortizations of USD1.5 billion and USD952 million during 2017 and 2018, respectively, which will be primarily addressed through the combination of FCF generation and refinancing. The company’s 2017 FCF generation is estimated in the USD500 million to USD700 million range. Furthermore, the company’s coverage ratio, measured as EBITDAR/(net interest Expense plus rents), is expected to be at 2.4x and 2.6x in 2017 and 2018, respectively.

FULL LIST OF RATING ACTIONS

LATAM Finance Limited:
Fitch has assigned an expected rating of ‘B+/RR4’ to LATAM’s proposed unsecured notes to be issued through its fully owned subsidiary LATAM Finance Limited. The notes will be fully guaranteed by LATAM.

Fitch currently rates LATAM and TAM S.A. as follows:

LATAM Airlines Group S.A.:
—Long-Term Foreign Currency IDR ‘B+’;
—National Equity Rating ‘Primera Clase Nivel 3 (cl)’
—USD500 million senior unsecured note due 2020 ‘B+/RR4’.

TAM S.A.
-Long-Term Foreign Currency IDR ‘B+’;
—Long-Term Local currency IDR ‘B+’;
—National long-term rating ’A(bra)’.

Tam Linhas Aereas S.A.
-Long-Term Foreign Currency IDR ‘B+’;
—Long-Term Local currency IDR ‘B+’;
—National long-term rating ’A(bra)’.

Tam Capital Inc.
—USD300 million senior unsecured note due 2017 ‘B+/RR4’.

Tam Capital Inc. 3
—USD500 million senior unsecured note due 2021 ‘B+/RR4’.

The Rating Outlook for the corporate ratings is Stable.