S&P: Mongolia Long-Term Rating Lowered To 'B-' On Weakening Fiscal And Growth Performance; Outlook Stable
We also raised to 'BB-' from 'B+' our issue rating on Styrolution's first-lien term loan due in 2019, which is split between a €517.12 million tranche and a $652.61 million tranche.
At the same time, we revised our recovery rating on the term loan to '2' from '3', indicating our expectation of 70%-90% recovery prospects (at the lower end of the range) in the event of a payment default.
Our affirmation reflects the significant strengthening in Styrolution's credit metrics. Its S&P Global Ratings-adjusted (gross) debt to EBITDA fell to 2.1x in 2015 from 4.9x in 2014, and we forecast a further improvement to 2.0x this year. At the same time, however, we recognize that the company could take advantage of its considerable rating headroom to utilize cash flows for dividends and to support growth initiatives.
Considering that we calculate Styrolution's leverage on gross basis, the key driver behind the meaningful reduction in leverage is its EBITDA growth. This reflects a top-of-the-cycle industry environment in 2015 and 2016, with styrene benzene spreads of $280 per metric ton on average in the year to date, and over $330 per metric ton in 2015 (partly due exceptional cracker outages in the second quarter). Styrolution's profitability is additionally supported by cost-saving initiatives and synergies with INEOS. We have therefore revised our financial risk profile assessment upward to significant from aggressive, factoring in the improved forecast metrics but also potential wide variations over the cycle.
We anticipate that strong industry conditions will continue in 2016 and well into 2017 on the back of ongoing strong demand for styrenics from packaging, leisure, automotive, and household sectors in Europe and North America, which form about 80% of Styrolution's end markets. Our forecast is notwithstanding weakening in Asia (notably China) affecting the polymer business, especially ABS (acrylonitrile butadiene styrene).
Under our base-case scenario, we forecast Styrolution to report high mid-cycle EBITDA after special items of about €740 million-€750 million in 2016 and €600 million-€620 million in 2017.
In our base-case, we assume:Reported EBITDA margin of about 17% in 2016, reflecting high mid-cycle conditions during the year, trending down to 14%-15% in 2017;Capital expenditure (capex) of about €140 million in both years; andDividends at about 50% of net income of the previous year. Based on these assumptions, we arrive at the following credit metrics:Adjusted debt-to-EBITDA ratio of about 2.0x in 2016, and about 2.4x in 2017 (based on adjusted gross debt of €1.5 billion).Strong free operating cash flow in both years. We continue to view Styrolution's business risk profile as constrained by the commodity nature of its products and its limited diversification as a pure-play styrenics producer. This implies high cyclicality of earnings and cash flows during periods of lower demand in the company's more cyclical end-markets--including consumer durables, packaging, automotive, and construction. In addition, volatility in raw material prices (such as benzene) could erode profitability.
Styrolution benefits from a large-scale, integrated, and cost-competitive asset base, as 75% of its production assets are positioned in the first and second quartile of the industry cost curve. In addition, we factor in the company's successful track record and focus on costs and efficiencies.
As an indirectly and fully owned subsidiary of INEOS AG, we assess Styrolution's management and governance score as fair, in line with our assessment for its sister companies, Inovyn and INEOS Group Holdings S. A. This reflects our view of the concentrated ownership of INEOS--100% of shares are held by only three individuals--partly offset by our view of the management's entrepreneurial cost focus and industry knowledge.
We believe Styrolution's future credit metrics could be weaker than our base case suggests. This reflects our view that certain management actions, such as higher capex to support capacity expansions, or debt-financed dividends, could contribute to higher leverage than we currently forecast.
At the same time, we view Styrolution as a moderately strategic subsidiary of INEOS AG, reflecting our understanding that INEOS' policy is to fund the group on a stand-alone basis. Therefore, the rating currently incorporates no adjustment for group support, and would likely remain at or below the 'b+' group credit profile of INEOS AG.
The stable outlook reflects our view that Styrolution will be able to maintain a strong operating performance in the coming years, with EBITDA of about €740 million-€750 million in 2016 and €600 million-€620 million in 2017. This assumes a drop in styrene-to-benzene spreads to more normalized levels from top-of-the-cycle profits in 2015 and 2016. We forecast an adjusted ratio of (gross) debt to EBITDA of about 2.0x in 2016 and about 2.4x in 2017. This is commensurate with the rating, which assumes leverage of between 2.5x-3.0x in top-of-the-cycle conditions, and between 4.0x-4.5x at the bottom of the cycle.
Rating pressure could develop due to a combination of a deteriorated market environment, and releveraging through unexpected dividends or acquisitions, such that the ratio of adjusted (gross) debt-to-EBITDA rises to about 4x-5x.
We see limited near-term likelihood of an upgrade, given the volatility of the styrenics industry and Styrolution's current material gross debt. We also expect the company to remain ambitious and that it may finance an expansion of the business partly with debt. A higher rating would therefore depend on Styrolution taking clear actions to reduce debt and making a commitment to keep leverage sustainably below 3x, in combination with a wider improvement in the credit quality of the INEOS AG group.