Fitch Affirms RPM's IDR at 'BBB-'; Outlook Revised to Positive
KEY RATING DRIVERS
The ratings for RPM reflect the company's well-balanced portfolio of products, geographic and end-market diversity, solid liquidity position, stable credit metrics and consistent free cash flow (FCF) generation. Risks include the cyclicality of the company's end-markets and growth through acquisition strategy.
The revision of the Outlook to Positive from Stable reflects the resolution of the company's asbestos litigation and the elimination of the uncertainty as to RPM's potential liability related to these asbestos claims. The Positive Outlook also incorporates Fitch's expectations that the company's credit metrics will improve in the intermediate term, including debt to EBITDA sustained in the 2.0x-2.5x range, FFO adjusted leverage situating between 3.0x-3.5x and interest coverage consistently above 7.0x.
RESOLUTION OF ASBESTOS LITIGATION
On Dec. 10, 2014, a bankruptcy plan was confirmed for RPM's subsidiary, Bondex International Inc. (Bondex), and its parent, Specialty Products Holding Corp. (SPHC), effective Dec. 23, 2014 (the effective date), allowing the subsidiary to emerge from bankruptcy (filed in May 2010). Following the confirmation of the bankruptcy plan, the financial results of SPHC have been reconsolidated with RPM's results as of Jan. 1, 2015. SPHC has annual revenues of about $400 million.
In accordance with the bankruptcy plan, a trust was established under Section 524(g) of the U.S. Bankruptcy Code for the benefit of current and future asbestos personal injury claimants. The trust assumed all liability and responsibility for current and future personal injury claims, and the entities will have no further liability or responsibility for and will be permanently protected from such asbestos claims.
The trust was initially funded with $450 million in cash and a promissory note, bearing no interest and maturing on or before the fourth anniversary of the effective date. The plan provides for the following additional contributions to the trust:
--On or before the second anniversary of the effective date of the plan, an additional $102.5 million in cash, RPM stock or a combination of both, at the discretion of RPM (for this payment and all subsequent payments), will be deposited to the trust;
--On or before the third anniversary of the effective date, an additional $120 million in cash, RPM stock, or a combination of both, will be deposited to the trust, and;
--On or before the fourth anniversary of the effective date, a final payment of $125 million in cash, RPM stock, or a combination of both, will be deposited to the trust.
The contributions to the trust are deductible for U.S. income tax purposes.
The initial $450 million payment to the trust was funded by borrowings under the company's $800 million revolving credit facility. In May 2015, RPM issued $250 million of senior notes to repay a portion of the borrowings under the revolver.
Although the confirmation of the bankruptcy plan requires a meaningful payment, Fitch views the resolution positively as this resolves the uncertainty regarding potential liabilities associated with the asbestos litigation.
SOLID LIQUIDITY POSITION
RPM has solid liquidity and is able to meet its financial obligations, including the remaining installments to the asbestos trust. As of Aug. 31, 2015, the company had cash of $169.5 million ($139.5 million held at various foreign subsidiaries), $612.7 million available under its $800 million revolving credit agreement (maturing in December 2019) and $100 million available under its $200 million Accounts Receivable Securitization program (maturing in May 2017). Fitch believes that the company will have continued access to its credit facilities as RPM has sufficient cushion under its financial covenants. As of Aug. 31, 2015, RPM's leverage was 56% vs. a maximum requirement of 65% and its interest coverage was 8.8x vs. a minimum requirement of 3.5x. The company has no long-term debt maturities until February 2018, when $250 million of senior notes become due
STABLE CREDIT METRICS
The company's credit metrics have been relatively stable over the past few years. Debt to EBITDA was 2.6x for the latest-12-months (LTM) period ending Aug. 31, 2015 compared with 2.5x at the end of FY15 and 2.3x at the conclusion of FY14. FFO adjusted leverage was 4.1x for the LTM period compared with 3.8x at the end of FY15 and FY14. EBITDA to interest coverage was 7.2x for the Aug. 31, 2015 LTM period compared with 7.4x for FY15 and FY14.
Fitch expects RPM's credit metrics will improve during FY16 as the full year of SPHC's operations are fully reflected in the company's financial results. Fitch expects debt to EBITDA will be below 2.5x and FFO adjusted leverage will be under 3.5x at the end of FY16. Fitch expects EBITDA to interest coverage will remain above 7.0x during FY16.
CONSISTENT FREE CASH FLOW GENERATION
RPM generated $238.1 million of FCF (5.1% of revenues) for the LTM period ending Aug. 31, 2015 compared with $108.8 million (2.4%) during FY15, $58.7 million (1.3%) during FY14 and $159.5 million (3.9%) during FY13. The FCF during FY14 includes a one-time GSA-settlement payment of $61.9 million. For the LTM period ending Aug. 31, 2015, working capital increased FCF by about $67.4 million. Management indicated that the working capital benefit was due to faster collections and the timing of disbursements during the most recent quarter. Fitch expects the company will generate FCF of about 3.0%-3.5% of revenues during the next few years.
GROWTH THROUGH ACQUISITION STRATEGY
RPM uses acquisitions to augment its organic growth. Since 2006, RPM has spent about $1.22 billion on acquisitions (excluding SPHC, which was accounted for as an acquisition in the reconsolidation), including $72.7 million for six acquisitions during FY15, $39.5 million for four acquisitions in FY14 and $404.3 million for six acquisitions during FY13.
Fitch believes that RPM employs a disciplined process and acquires businesses with strong margins in markets they are familiar with. The company typically targets small, bolt-on acquisitions that are usually adjacent products and/or geographic extensions. About half of the company's growth over the past 30 years has been driven by acquisitions, and Fitch expects RPM will continue to pursue acquisitions as part of its growth strategy.
CYCLICALITY OF END MARKETS
RPM is exposed to cyclical end markets including new residential and commercial construction and residential and commercial repair and maintenance. Management estimates that approximately 70% of worldwide sales are directed towards the repair and maintenance market, which is somewhat less volatile than the new construction market. RPM generates about 60% of its revenues from the U.S.
During the last U.S. economic and construction downturn, RPM's sales fell 7.6% during FY09, grew 1.3% during FY10 and then contracted 0.9% during FY11. RPM's EBITDA margins declined nearly 250 bps during FY09 but rebounded by almost 200 bps during FY10 and expanded close to 60 bps during FY11. Nevertheless, debt to EBITDA remained below 3.0x and EBITDA to interest coverage continued to be above 6.0x during these periods.
Fitch expects continued growth in overall U.S. construction spending through 2016.
Fitch's key assumptions within our rating case for the issuer include:
--U.S. construction spending increases 7.7% during 2015 and 7.1% during 2016;
--Overall sales growth of 7%-9% during FY16 (ending May 31, 2016), including full year results of SPHC (reconsolidated on Jan. 1, 2015);
--EBITDA margins of 14%-14.5% during FY16;
--FCF margin of 3.0%-3.5% during FY16;
--Debt to EBITDA below 2.5x, FFO adjusted leverage under 3.5x and EBITDA to interest coverage above 7.0x;
--No meaningful share repurchases in the near to intermediate term.
--Debt reduction and/or EBITDA/FFO growth, resulting in sustained improvement in credit metrics, including debt to EBITDA consistently in the 2.0x - 2.50x range, FFO adjusted leverage sustained in the 3.0x-3.50x range, and EBITDA to interest coverage above 7x on a continuing basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A sustained erosion of profits and cash flows either due to weak residential and commercial construction activity, loss of market share or as the result of long-term higher raw material costs, leading to EBITDA margins sustained below 12%, debt to EBITDA consistently above 3.0x and interest coverage below 5.0x.
--Leveraged acquisitions which result in debt to EBITDA sustainably over 3.0x;
--Dividends that claim most internally generated cash flow.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings with a Positive Outlook:
RPM International Inc.
--IDR at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Unsecured revolving credit facility at 'BBB-'.