OREANDA-NEWS. S&P Global Ratings said today that it has raised its long-term corporate credit rating on Norway-based publication paper producer Norske Skogindustrier ASA to 'CCC+' from 'CCC-'. The outlook is stable.

The 'C' short-term corporate credit rating was affirmed.

At the same time, we raised our issue rating on the company's senior secured notes to 'CCC+' from 'CCC-'. We revised the recovery rating to '3' from '4', indicating our expectation of recovery in the lower half of the 50%-70% in the event of a default.

We also raised our issue rating on the company's senior unsecured notes to 'CCC-' from 'C'. Our '6' recovery rating on these notes remains unchanged, indicating negligible (0%-10%) recovery prospects in a default scenario.

We removed all the ratings from CreditWatch, where we placed them with developing implications on April 29, 2016.

The upgrade follows Norske Skog's repayment of its notes due in June 2016 and improved operational performance in the first half of this year. The company now faces limited debt maturities until late 2019 and therefore has some time to further strengthen its earnings base and diversify away from publication paper. However, our 'CCC+' rating indicates that we still regard the capital structure as unsustainable in the long term, although we view the risk of a default as limited in the coming 12 months. We think that Norske Skog's ability to meet future debt maturities will remain highly dependent on favorable economic, financial, and industry conditions.

We consider Norske Skog's business risk profile to be vulnerable, since its business model is fully exposed to publication paper used for newspapers, magazines, direct advertising, and books. The market for newsprint and magazine paper in Europe and Australia is depressed, with structurally falling demand due to ongoing digitalization and periods of overcapacity, which lead to recurring price pressure. Although capacity closures occur on a regular basis, they often have a limited impact on pricing because demand keeps declining as the market remains fragmented. Several smaller players compete for market share, which limits sustained improvement in profitability. We think that Norske Skog's new business strategy to diversify away from paper (for example into biogas, pellets, and tissue paper) makes sense, but that the financial impact will be relatively small over the next few years compared with that of the existing paper business. In addition, these investments come with execution and timing risks, as highlighted by the cancellation of a partnership to convert a paper machine to produce tissue paper at the Bruck mill in Austria.

We view Norske Skog's highly leveraged financial risk profile as a constraint to the rating. Although the company has managed to cut debt through its recent debt exchange, rights issue, and repayment of debt maturities, we think that further deleveraging is highly dependent on the company's ability to increase profitability in the paper segment as well as deliver growth projects on time and on budget. We think that adjusted debt to EBITDA will be at about 7.5x in 2016 and possibly decrease further in 2017 and 2018, depending on operational performance and capital expenditure (capex) levels.

The stable outlook takes into account our forecast that Norske Skog's EBITDA margins will remain at about 10% and internal cost-cutting efforts will offset weakness in paper prices. We expect the company will manage its growth investments carefully and that cash flow after investments will stay slightly positive in the coming three years.

We could lower the rating if Norske Skog's operational performance were to deteriorate, for example as a result of downward pressure on paper prices or rapidly increasing input costs. We could also downgrade the company if it announced another financial restructuring.

Although highly unlikely in the coming 12 months, we could consider raising the rating if Norske Skog's operational performance improved substantially and we believed that the improvement could be sustained for a number of years. This could be the result of improved conditions in the European paper market, likely including consolidation and sustained price increases, and the company's successful diversification beyond paper, which would remove uncertainty regarding the refinancing of debt maturities in 2019.