OREANDA-NEWS. Fitch Ratings has revised Smurfit Kappa Group plc's (SKG) Outlook to Negative from Stable and affirmed its Long-term foreign currency Issuer Default Rating (IDR) and the senior unsecured ratings of Smurfit Kappa Acquisitions and Smurfit Kappa Treasury Funding at 'BB+'. The rating actions follow SKG's acquisition of two Brazilian paper-based packaging businesses, Industria de Embalagens Santana (INPA) and Paema Embalagens (Paema), for a total consideration of EUR186m.

The revision of the Outlook reflects SKG's faster than expected ramp-up of acquisitions and shareholder returns at a time when its financial profile has not yet improved to a level that is commensurate with its 'BB+' rating. Priced at multiples of 6.3x EBITDA (including synergies) and 8.0x EBITDA (excluding synergies), INPA and Paema will result in total acquisitions of over EUR350m in 2015 according to Fitch's estimates, well in excess of around EUR185m Fitch-calculated (post dividends) free cash flow (FCF) generated in 2014. Fitch forecasts pro-forma funds from operations (FFO) adjusted net leverage of nearly 3.5x at end-2015 reducing to around 3.25x over the next 12 to 18 months. This assumes increasing capex and shareholder returns and a slower pace of acquisitions than in 2015.

The affirmation reflects SKG's improving business profile, strong market positions, attractiveness to multinational customers and exposure to fast moving consumer goods, which has contributed to relatively stable, positive cash flow through the cycle. It also recognises SKG's excellent liquidity and the deleveraging and reduced funding costs management has achieved over the past years.

KEY RATING DRIVERS
Latam Acquisitions
The EUR186m acquisitions in Brazil are the latest in a string of acquisitions in Latin America, including the Dominican Republic, El Salvador and Costa Rica, with the aim of diversifying from Western Europe. They reinforce the group's position as the largest corrugated packaging supplier in the region and improve its attractiveness to multinational customers. Brazil contributes 40% of Latin American corrugated demand. INPA and Paema benefit from integrated operations that add three recycled containerboard mills and four corrugated box plants to SKG's roster. Management intends to reap synergies resulting in an uplift of around 25% of the targets' current EBITDA.

Shift in Strategy
Fitch considers management's public commitment to a 'BB+' rating as credit positive, although the strategic focus has shifted towards acquisition- and capex-driven growth and shareholder returns from debt reduction. We will monitor the pace of acquisitions and their successful integration into the group over the next 12 to 18 months.

YTD Trading and Cost Cutting
Operating performance is solid, with corrugated packaging volumes growing by over 6% in the first nine months of 2015 as result of acquisitions and 2% group organic growth. Fitch forecasts flat earnings for 2015 year-on-year, despite FX headwinds due to the adoption of the Simadi exchange rate in Venezuela, which now accounts for only 1% of group EBITDA. Management's continued commitment to cut EUR75m in costs and to optimise its asset base by closing four corrugated box plants and a mill in 2015 support sustainable improvements in its cost structure.

Leading Positions
SKG's ratings are supported by its leading market positions in corrugated containers as the largest European and pan-American packaging company. The group's business profile also benefits from its exposure to fairly stable packaging markets; around 60% of its revenues are generated in fast moving consumer goods. Its vertical integration into containerboard provides some margin protection against raw material cost inflation.

Stable Cash Flow
The group's positive free cash flow (FCF) generation through the cycle is credit-supportive. We forecast continued positive (post-dividends) FCF in excess of EUR100m, supported by healthy current trading and cost-cutting programme. This is despite its sizeable and increasing dividends and capex.

KEY ASSUMPTIONS
- Capex and M&A-driven revenue growth
- Moderate margin accretion from cost cutting and margin accretive investments.
- Increasing dividends and capex in excess of EUR600m over the coming years.
- Continued acquisitions of around EUR200m per year.

RATING SENSITIVITIES
Future developments that could lead to positive rating action include:
- Increased geographic and product diversification.
- FFO adjusted net leverage below 2.0x.
- FCF margin above 2.5%.

Future developments that could lead to negative rating action include:
- Evidence of aggressive acquisitions or shareholder returns.
- FFO adjusted net leverage above 3.0x on a sustained basis.
- FCF margin below 1%.

LIQUIDITY
SKG had liquidity consisting of EUR263m in cash (of which Fitch considers EUR100m as tied up for working capital and other operational requirements) and a EUR520m undrawn revolving credit facility compared with EUR86m in short-term debt maturities at end 3Q15. Coupled with positive FCF expected for the following 12 months, this should provide ample headroom.