Fitch Affirms Magnesita's IDRs at 'BB'; Outlook Negative
KEY RATING DRIVERS
Magnesita's Negative Outlook reflects its ongoing challenges to reduce its high leverage ratios in light of the company's large exposure to the sluggish near-term performance of the global steel industry. Magnesita's ability to continue to gain market share in North America, as well as a production rebound in this particular region as a benefit of recent trade policies, may prove to be a positive catalyst. Recently Magnesita's operating cash flow has shown some improvement as a result of better working capital management and SG&A cost initiatives. Nevertheless, the depreciation of the BRL versus the USD has increased the company's indebtedness level.
Fitch's base case for Magnesita indicates that its net debt to EBITDA ratio will reach 4.7x in 2015, with a decline to around 3.8x in 2016. This expected improvement by the end of next year is not considered sufficient to stabilize Magnesita's ratings at 'BB' at this time. Given its operating cash flow volatilities, Fitch would expect the company to maintain consistency on net leverage at 3.5x or below to refrain from a downgrade over the next 12 to 24 months. The agency expects Magnesita to keep its track record of a conservative financial policy, underpinned by robust cash holdings and a well-spread long-term debt schedule amortization in order to avoid refinancing risks.
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 BRL3 billion in revenues during the last 12-month period (LTM) ended on June 30 2015, 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; Adequate Profitability
Magnesita has large exposure to the cyclical steel industry, which accounted for 74% of consolidated revenues in June 2015. 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's contribution to the company's revenues to 28% in 2014 from 36% in 2012. During 2015, Fitch expects this percentage to decline to 25% and to remain in the range of 20%-25% in the medium term. Magnesita's share of service for the Brazilian steel market is around 70%, but in other regions with improving steel industry prospects, such as the U.S., it has greater growth potential. Magnesita currently has an estimated U.S. market-share of around 20%.
Despite the steel sector's volatility, Magnesita has been able to maintain relatively stable EBITDA margins. Nevertheless, the ongoing geographical diversification and strategy to develop non-core markets have demanded higher operating expenses and pressured its profitability. Fitch expects Magnesita's EBITDA to trend around 14% during the next three years, a decline from the historical 15%, yet it is still sound compared to its peers which exhibit average EBITDA margins of around 12%.
Improvement in Operating Cash Flow; High Interest Expenses Continues to Pressure
Since 2014, Magnesita has been working to improve its operating cash flow (CFFO) generation towards working capital efficiencies and SG&A costs initiatives. During the LTM ended June 30, 2015, Magnesita's EBITDA reached BRL399 million, an increase from BRL358 million in 2014, but still below BRL420 million in 2013.
The company's funds from operations (FFO) have improved, but remain weak mostly due to its high interest expense burden. Seeking to reduce interests outflows and total leverage, the company has just completed a tender offer for its USD400 million 2020 bonds that has resulted in only USD66 million of the bonds remaining outstanding. To fund this transaction, Magnesita used a mix of cash and proceeds from a USD160 million syndicated loans due 2020, which was arranged by Bradesco and Bladex at more attractive interest rates.
The company's improved working capital management drove improvements in CFFO. During 2014 and the LTM June 2015, working capital outflow was BRL86 million and BRL43 million, respectively. In the same period, CFFO grew to BRL192 million in June 30, 2015 from BRL142 million in 2014. Magnesita's capex has remained around BRL205 million, which led to a negative free cash flow (FCF) position of BRL14.3 million during LTM June 30 2015.
Leverage Remains High; Decline Expected
The BRL devaluation has been pressuring Magnesita's net leverage ratios. As of June, 30 2015, the company had BRL2.8 billion of debt, with 64% of it being denominated in USD. As of June 30, 2015, the company's total and net adjusted debt-to-LTM EBITDA ratios were 6.9x and 4.8x, respectively, compared to 5.8x and 3.5x for 2013 and 5.2x and 2.9x for 2012. Fitch includes BRL21 million related to future obligations from acquisitions in Magnesita's total adjusted debt. In the medium term, foreign exchange risk for the company is mitigated due to its geographic diversification, as approximately 70% of its EBITDA is generated in foreign currency compared to 68% of its debt denominated in USD and EUR.
Fitch's base case indicates EBITDA generation at around BRL455 million for 2015, with EBITDA margins slightly above 14%. FCF is expected to be neutral to slightly positive following capex, with net adjusted debt-to-EBITDA showing a marginal improvement to 4.7x. Going forward in 2016, the company's high export revenues volume should benefit from the expected continuation of the BRL devaluation and increase its operating cash flow generation, leading to a decline in the Magnesita's net adjusted debt to EBITDA ratio to around 3.8x.
--Low-digit revenue growth from 2016 onward;
--Softer but still resilient EBITDA margins - EBITDA margin in the 13%-15% range (14% expected at fiscal year-end 2015);
--Capex at around BRL240 million per year and dividends at 25% from 2017 onwards;
--Cash balance remains sound compared to short-term debt;
--Reserve life replenished annually;
--No large-scale M&A activity.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--An upgrade is unlikely in the next 12-18 months due to the slow pace of deleveraging;
--Stabilizing the Outlook is dependent on the issuer's ability to achieve a net leverage ratio around 3.5x or below by the end of 2016 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 declining below current levels on a sustained basis;
--Net adjusted leverage remaining above 3.5x during the next 12 to 24 months;
--Deterioration of sound liquidity compared to short-term debt, leading to refinancing risk exposure;
--Large debt-funded M&A acquisition that adversely impacts Magnesita's capital structure on a sustained basis.
Magnesita has a track record of keeping strong cash balances, with cash covering short-term debt by an average 4.9x during the last five years. As of June 30, 2015, the company had BRL2.8 billion of debt, of which BRL488 million is due in the short term, while cash and marketable securities was solid at BRL838 million. Following the tender offer, Fitch expects Magnesita cash balance to reduce to around BRL480 million, a level that should remain adequate for medium term maturities up to mid-2018. The agency expects Magnesita to keep its track record of conservative financial policy, underpinned by solid cash holdings and a well-spread long term debt schedule amortization in order to avoid refinancing risk.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Magnesita Refratarios S.A.
--Foreign currency long-term IDR at 'BB';
--Local currency long-term IDR at 'BB';
--National long-term rating at 'A+(bra)';
--Local Debentures issuance at 'A+(bra)'.
Magnesita Finance Ltd.
--Senior unsecured ratings at 'BB'.
The Rating Outlook is Negative.