OREANDA-NEWS. S&P Global Ratings today affirmed its 'BB' global scale ratings and 'brA+' national scale rating on Magnesita Refratarios S. A. The outlook is negative.

At the same time, we affirmed the 'BB' issue level rating assigned to Magnesita's senior unsecured debt. The recovery rating remains '4', indicating our expectation of average recovery (30%-50%, in the higher end of the range) in the event of a default.

The ratings affirmation reflects our view that Magnesita's individual credit quality won't change at least in the next 12 months as a result of the deal with RHI AG, which, if approved by shareholders and antitrust authorities, will result in the largest refractory production group globally. In the long term, we expect the companies to have synergy gains due to the fact that Magnesita's market position is complementary to that of RHI, therefore the deal expands the group's diversification to a broader market. However, we believe potential short-term benefits to be marginal and not strong enough to offset the risks that drive our negative outlook on the ratings, such as the weak market conditions for Magnesita's main clients in the metals industry. Furthermore, uncertainties regarding the conclusion of the deal, such as approval from antitrust agencies and additional leverage at RHI needed to fund the transaction, also overshadow potential benefits to the consolidated credit quality of the combined entities.

The negative outlook continues to reflect our expectations that Magnesita remains challenged to improve its financial metrics over the next few quarters in a scenario of weak market conditions for some of the main industries it is exposed to, such as metals producers. These weak market conditions will continue to pressure the company's cash generation, leading to a funds from operations (FFO)-to-debt ratio of about 12% by year-end 2016, which we continue to see as weak for Magnesita's current rating category.

We could downgrade Magnesita if further weakness in cash generation driven by lower-than-expected demand volumes and/or margins prevents the company from lowering its debt-to-EBITDA metrics to below 4.0x, and FFO to debt approaching 20%. We could also lower the ratings if the company's leverage also deteriorates following the deal, mainly as a result of additional debt raised at the Magnesita level, or if we believe the combined credit quality of both entities to be weaker than Magnesita's curret rating category.

An upgrade in the near term is unlikely, but we could revise the outlook to stable if Magnesita generates stronger cash flow leading to healthier financial metrics, such as FFO to debt consistently above 20% and free operating cash flow to debt above 5%. We could also revise the outlook to stable if, following the conclusion of the transaction, we believe the combined company's credit quality to be stronger than that of Magnesita on a stand-alone basis, either by having a stronger business risk profile, or combined financial metrics that are commensurate with the 'BB' rating category.