Fitch Affirms Magnesita's IDRs at 'BB'; Outlook Negative
The Negative Outlook on the ratings reflects Magnesita's slower than expected deleveraging. The company's net leverage has been trending higher than Fitch's base case expectations and is not commensurate with current ratings. Within the next 12-to-18-month time horizon, the company has the challenge to generate free cash flow to facilitate a reduction in net debt-to-EBITDA to around 3.5x or below. Fitch expects the company to actively seek options to support a swifter deleveraging process in order to avoid a rating downgrade in the medium term.
Fitch anticipates the company will continue to develop its business into new markets and regions, bringing benefits in terms of business diversification; nonetheless its cost-cutting initiatives and SG&A dilution may not be sufficient to fully offset pressures on profitability. Magnesita's EBITDA margins are expected to vary between 13%-15% from 2015 to 2018 taking into account these developments.
KEY RATING DRIVERS:
Solid Business Profile; Vertical Integration:
Magnesita's ratings are supported by its low-cost and vertically integrated business model, long-life mine reserves, geographical diversification, and its position as the world's third largest refractory manufacturer in a highly fragmented market. The company's core business is refractory solutions, comprising 89% of BRL2.9 billion in revenues during the 12-month period ended on Sept. 30 2014, followed by its services business line (6%), and its minerals segment (5%). The company has strong long-term relationships with customers throughout the world, including the largest Brazilian steel producers, as well as leading Brazilian and international cement producers.
Increasing Geographical Diversification; Profitability Should Decrease but Still Well-Positioned within Peers:
Magnesita has large exposure to the cyclical steel industry, which accounted for 74% of consolidated revenues in September 2014. Over the last two years, the company has successfully intensified its geographical diversification strategy, aiming to reduce its dependence on the Brazilian steel industry. This has resulted in a reduction of Brazil total share in revenues to 28% in 2014 from 36% in 2012. During 2015, Fitch expects it to decline to 25% and to remain in the range of 20%-25% in the medium term. Magnesita's market share in Brazil is around 80%, but in other regions with improving steel industry prospects, such as the U.S., it has greater growth potential. Magnesita's estimated US market-share is 20%. For 2015, Fitch expects this market to represent around 26% of Magnesita's revenues.
Despite the steel sector's volatility, since 2008 Magnesita has been able to maintain relatively stable EBITDA margins. Its solid business model has supported a track record of industry-leading EBITDA margins close to 15%. Nevertheless, the ongoing geographical diversification and strategy to develop non-core markets have demanded higher operating expenses and pressured its profitability. Magnesita's EBITDA is expected trend down to the range of 13%-15% in the next three years, yet it is still sound compared to its peers which exhibit average EBITDA margins of around 12%.
Operating Cash Flow Still Weak; Rebound in Working Capital
Magnesita's funds from operations (FFO) is still weak, mostly impacted by its high interest expense burden and the ongoing restructuring of its operations abroad. Positively, during 2014 the company benefited from improved working capital as a result of efficiency measures. In 2013, the company's more aggressive commercial strategy pressured its working capital requirements due to the need to build inventory levels in new points of sales. During the LTM September 2014, working capital requirements decreased to BRL21 million compared to BRL150 million in 2013. Operating cash FFO (CFFO) improved to BRL91 million in Sept. 30, 2014 from BRL7 million in 2013, but it is still below the average of BRL190 million in the 2009-2013 period. The company is currently aiming to work on liability management strategies in order to reduce interest expenses financed.
The conclusion of the capex related to the Brumado mine has helped to reduce pressure on Magnesita's total capex (BRL178 million) and on free cash flow (FCF) generation in 2014. Magnesita's total capex averaged BRL226 million during 2010-2013. Magnesita's dividend payments are conservative at 25% of net income with BRL17 million paid for September 2014. During the LTM September 2014, FCF was negative BRL77 million, an improvement from the negative BRL214 million in 2013. For 2014, Fitch expects Magnesita's FCF to be neutral to slightly negative.
Leverage is High; Limited Medium-Term Improvement Expected
Magnesita's weaker EBITDA generation and BRL devaluation have pressured the company's net leverage ratios. As of Sept. 30, 2104, the company's total and net adjusted debt-to-LTM EBITDA ratios were 6.1x and 3.9x, respectively, compared to 5.8x and 3.5x for 2013 and 5.2x and 2.9x for 2012. Fitch includes BRL24 million related to future obligations from acquisitions in Magnesita's total adjusted debt. Foreign exchange risk for the company in the medium term is partially mitigated due to its geographic diversification, as approximately 70% of its EBITDA is generated in foreign currency compared to 61% of its debt denominated in USD and EUR.
Fitch's Base Case indicates adjusted EBITDA generation at around BRL420 million for 2015, with EBITDA margins around 14%. FCF is expected to be neutral to slightly negative by around BRL20 million following capex, with FFO interest coverage at about 1.8x and net adjusted debt-to-EBITDA improving to around 3.6x.
Solid Liquidity Position
Magnesita's liquidity position indicates comfortable headroom for the rating category, ending Sept. 30, 2014 with BRL885 million of cash and marketable securities compared to short-term debt of BRL286 million. Liquidity ratios are strong with cash-to-short-term debt at 6.5x and cash plus CFFO-to-short-term debt at 7.3x. Magnesita's debt amortization schedule is manageable, with BRL286 million in short-term and BRL476 million spread over the next three years. The company's cash position is enough to meet all current debt maturities through 2017.
Minerals Segment Expansion Suspended; Business Diversification Limited
Magnesita recently announced its decision to suspend the development of graphite mines in Almenara and Aguas Belas (Minas Gerais) due to greater than expected capex needs. The mines have potential resources of 48 million tons, considering the potential exploration areas in both areas, which could be processed at the same facility. Proven resources would allow for an operation of approximately six years, with annual production of around 40,000 tons. The project was expected to be positive to Magnesita and lead to further business diversification and high profitability levels.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include:
--Low-digits revenue growth from 2015 onward;
--Softer but still resilient EBITDA margins - EBITDA margin in the 13%-15% range (14% expected at fiscal year-end 2015);
--Capex at around BRL210 million per year and dividends remaining at 25%;
--Cash balance remains sound compared to short-term debt;
--Reserve life replenished annually;
--Net adjusted debt-to-EBITDA trending toward 3.5x;
--No large-scale M&A activity.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--An upgrade is not likely in the next 12-18 months due to the slow pace of deleverage process;
--Stabilizing the Outlook is dependent on the issuer's ability to achieve a net leverage ratio below 3.5x by the end of 2015 through an improvement in operating cash flow generation or an asset sale.
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
--Prolonged downturn in the cyclical steel and cement markets that hampers production volumes globally;
--Market share erosion in Brazilian market;
--EBITDA margins falling and remaining below 13%;
--Net adjusted leverage remaining above 3.5x;
--Deterioration of sound liquidity of short-term debt, leading to refinancing risk exposure;
--Large M&A acquisition that moves the company's leverage beyond 3.5x, on a sustainable basis.
Fitch has affirmed the following ratings:
Magnesita Refratarios S.A.
--Long-term IDR at 'BB';
--Local currency long-term IDR at 'BB';
--National long-term rating at 'A+(bra)'
--Magnesita Finance senior unsecured ratings at 'BB'.
In addition, Fitch has affirmed and withdrawn the following ratings:
Magnesita Finance Ltd
--Long-term IDR at 'BB';
--Local currency long-term IDR at 'BB'.
The Rating Outlook has been revised to Negative from Stable.
These ratings were withdrawn as these entities are no longer considered analytically meaningful for the credit quality of the notes that have been issued out of them. All of the aforementioned notes that were issued by these special purpose entities were fully guaranteed by Magnesita and the ratings of those issuances remain outstanding.
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