Over the past three years, the North American chemical companies that S&P Global Ratings downgraded to speculative grade ('BB+' and lower) from investment grade ('BBB-' and higher) have outnumbered those it has upgraded to investment grade. When a company is downgraded to speculative grade, we call it a "fallen angel," and we refer to one that crosses over to investment grade as a "rising star." This inflection point is of utmost importance to investors, lenders, and issuers because of what it means for the issuer's financial strength, covenant packages, access to and costs associated with capital markets, and the management of financial policies.
After a quiet 2018 in the chemicals sector in terms of rating transitions between investment grade and speculative grade, we see the possibility for two rising stars this year. The leading candidate is Huntsman Corp., which we upgraded to 'BB+' with a positive outlook in April 2018 following a substantial debt reduction.
Over the past 12 months, we've taken positive rating actions on other companies in the 'BB' category, such as Olin Corp. That momentum could carry them into the investment-grade category over time if performance and financial policies are supportive of such an action. Absent any unexpected financial policy decisions, we don't think we'll see any fallen angels in the American chemicals sector in 2019 because none of the companies we rate 'BBB-' have a negative outlook or ratings on CreditWatch with negative implications.
What Are Some Advantages Of An Investment-Grade Rating?
Beyond the lower cost of financing, an investment-grade rating:
- Enhances access to capital markets and broadens the investor base. Investment-grade companies typically are more readily able to tap the commercial paper markets for managing day-to-day cash needs.
- Typically negates posting collateral for debt issuance.
- Tends to be viewed favorably by suppliers and customers as well as sovereign governments, especially in asset-intensive businesses. In addition, trade partners often favor counterparties with an investment-grade rating.
- Usually coincides with a more conservative financial policy.
Recent Crossovers Between Speculative Grade And Investment Grade
There were no crossover rating actions in the U.S. chemicals industry in 2018. Over a broader three-year time horizon, we've downgraded three chemical companies to speculative grade (see Table 1), and we upgraded one to investment grade.
|American Chemical Company Speculative-/Investment-Grade Crossovers Since 2016|
|Company||To rating (and CreditWatch/outlook)||From rating (and CreditWatch/outlook)||Date||Reason|
H.B. Fuller Co.
|BB+/Negative/--||BBB-/CreditWatch Negative||Sept. 29, 2017||Debt-funded acquisition of Royal Holdings led to a significant increase in leverage.|
CF Industries Inc.
|BB+/Negative/--||BBB-/Negative/--||Oct. 17, 2016||Weak operating performance from lower-than-expected nitrogen fertilizer prices.|
|BB+/Negative/--||BBB-/Negative/--||Sept. 19, 2016||Weak credit metrics from depressed methanol prices as a result of the decline in crude oil prices and additional methanol supply coming online.|
Celanese US Holdings LLC
|BBB-/Stable/--||BB+/Positive/--||June 16, 2016||Public commitment to investment grade with stated leverage targets.|
|Source: S&P Global Ratings.|
What Will It Take to Cross Over To/From Investment Grade In 2019?
We currently rate several companies across the U.S. commodity and specialty chemicals sector in the 'BB' and 'BBB' categories. As always, any rating actions on these companies will depend on a variety of factors, including financial policy decisions and operational performance. As of Jan. 16, 2019, the following are companies rated from 'BB' to 'BBB' that are near the threshold between investment grade and speculative grade.
We upgraded Huntsman in April 2018 to 'BB+' from 'BB' (the outlook is positive), primarily due to the company's demonstrated willingness to pay down debt (it reduced debt by about $1.7 billion in 2017 using proceeds from the sale of Venator Materials LLC shares). We also expect Huntsman to improve its operating performance. We believe these favorable credit factors provide positive ratings momentum, which could lead us to upgrade Huntsman to investment grade in 2019. For this to occur, Huntsman's FFO to adjusted debt would need to exceed 45% on a sustained basis, with management committing to maintaining credit measures at these levels after factoring in plans for M&A, growth initiatives, and any shareholder rewards.
We upgraded Olin Corp. to BB+ (stable outlook) on April 23, 2018. This action was due to improved profitability and credit measures resulting from favorable chlor-alkali industry conditions. In particular, the supply from China has been constrained due to regulatory restrictions related to environmental and safety standards, which has resulted in more favorable market conditions for producers like Olin. We view credit measures as appropriate for the 'BB+' rating at this time. We would need to see further improvement in credit measures--specifically an improvement in FFO to adjusted debt to 30% (from about 22% on a last-12-month basis as of third-quarter 2018), along with management commitment to maintain credit measures at these levels--to consider an upgrade to investment grade. Achieving these credit measures would likely require further margin expansion due to favorable chlor-alkali chain pricing along with improved cash flow that is deployed to reduce debt.
Since we lowered our issuer credit rating on Methanex to 'BB+' from 'BBB-' in September 2016 due to increased methanol industry capacity leading to lower prices and weakening in Methanex's credit measures, conditions in the methanol market have significantly improved. The posted price for methanol in North America increased to above $480 per tonne in September 2018 compared with $276 per tonne in September 2016. We revised our outlook on Methanex to stable from negative on Aug. 17, 2017, due to strong demand for methanol, which led to price recovery in 2017 that has sustained and extended further in 2018. Uncertainty regarding the company's plans for future capacity expansion remains a key credit risk. We could raise the rating back to investment grade if weighted average FFO to adjusted debt exceeds 30% on a sustainable basis and if management is committed to credit measures at these levels, even after factoring in potential growth initiatives.
The Mosaic Co.
We lowered the corporate credit rating on fertilizer company Mosaic Co. on Dec. 19, 2016, to 'BBB-' from 'BBB', following the company's announcement of its $2.5 billion acquisition of the Vale Fertilizantes business from Vale S.A., half of which it funded with debt. As part of this transaction, the company took significant steps to publicly demonstrate its commitment to investment-grade credit measures. Specifically, Mosaic funded 50% of the purchase price with equity, and it has cut its dividend twice to preserve roughly $350 million in cash flow annually. Our outlook on Mosaic is stable. Its credit measures have benefitted recently from favorable potash and phosphate fertilizer pricing, and we expect the company to maintain financial policies that are supportive of the investment-grade rating.
We lowered our corporate credit rating on agricultural chemical company FMC Corp. on Nov. 1, 2017, to 'BBB-' (stable outlook) from 'BBB' and the short-term credit rating to 'A-3' from 'A-2' due to greater leverage funding the completion of its asset swap with E.I. DuPont DeNemours & Co. As part of the transaction, FMC divested its health and nutrition segment and acquired DuPont's crop protection business. Since the transaction, FMC has prioritized free cash flow to reduce debt in 2018, which has improved credit measures. The company also completed the initial public offering of a portion of its lithium business, Livent Corp., on Oct. 11, 2018. The company announced its intention to spin off the remainder of Livent in March 2019, and we expect to take a wholesale re-assessment of FMC around the time of the lithium spinoff.
HB Fuller Co.
Our ratings on H.B. Fuller crossed from 'BBB-' to 'BB+' on Sept. 29, 2017, following the close of its $1.575 billion debt-funded acquisition of Royal Holdings Inc., due to the significant increase in leverage from less than 3x adjusted debt to EBITDA before the transaction to over 6x at close. Since then, the company has improved margins and reduced debt modestly. The company's path back to investment grade would require substantial further debt reduction and margin expansion such that FFO to adjusted debt exceeds 20% on a weighted average sustainable basis. In our base case, we do not expect these credit measures to be achieved over the next 12 months.
We downgraded CF Industries on Oct. 17, 2016, following a period of weak operating results due to depressed nitrogen fertilizer prices as well as increased capital spending, which led to deteriorating credit measures as EBITDA declined. We revised the outlook to stable in December 2018 due to favorable conditions in the nitrogen fertilizer market, with limited new capacity additions and steadily rising demand leading to improved profitability and credit measures for CF Industries. Before returning the rating to investment grade, we would need to see credit measures strengthen such that FFO to adjusted debt approaches 45%, along with the expectation that FFO to adjusted debt would remain above 30% even in a future downturn.
Our rating on specialty chemical producer Innophos Inc. is constrained by limiting factors inherent in the business, particularly its narrow product mix and limited diversity. We believe that limited diversification in terms of end markets and raw material supply will continue to constrain the rating. Absent a transformative acquisition that materially improves diversification, we would not expect a crossover into investment grade over the next 12 months.
Versum Materials Inc.
Limited diversification is also a constraining factor for Versum Materials Inc. We upgraded Versum to 'BB+' with stable outlook in April 2018 due to improved credit measures and lower volatility. However, we view the rating as constrained by its narrow focus on the semi-conductor industry as well as high customer concentration. Absent a transformative acquisition that materially improves diversification, we would not expect a crossover into investment grade over the next 12 months.
J.M. Huber Corp.
J.M. Huber Corp. has enjoyed improved performance and credit measures recently, though uncertainty around financial policies has constrained the rating. The company currently has a large cash balance that has resulted in strong credit measures, but there is uncertainty regarding how the company will use this cash and how will debt reduction be prioritized. To consider an upgrade to investment grade, we would need to gain clarity regarding the company's financial policies and plans around intended uses of cash, whether for growth initiatives, M&A, shareholder rewards, or debt reduction.
Leverage Is Key To Investment-Grade Ratings
Leverage plays a critical role in our ratings process. Companies with investment-grade ratings generally have lower leverage, with adjusted debt to EBITDA below 4x in most cases. The precise threshold we consider will vary by company, depending on our assessment of the company's business risk in addition to other factors, such as expectations for volatility in credit measures. In other words, for a chemical company with stronger credit quality inherent in the business due to factors such as competitive advantage, diversification, operating efficiency, and profitability, we may have a higher leverage threshold to reach investment-grade ratings than for a company with weaker business risk.
When we evaluate credit measures, we typically consider two historical years, the current year, and two projected years to determine weighted-average credit measures. In some instances, such as when a company completes a transformational acquisition leading to a step change in leverage, we will modify the weightings to exclude historical years that would not be representative of future leverage. Our calculated leverage ratios take into account various adjustments. We adjust debt by adding back capitalized operating leases, tax-affected unfunded pension and post-retirement obligations, asset retirement obligations, environmental liabilities, and other off-balance-sheet liabilities, while netting off what we view as surplus cash on the company's balance sheet (see "Criteria - Corporates - General: Corporate Methodology: Ratios And Adjustments," published Nov. 19, 2017).
For U.S.-based chemical companies, the average of weighted average credit measures range from a little more than 1x for those rated 'BBB+' to more than 3.5x for those rated 'BB-'. With the exception of the 'BBB-' rating category (because only three chemical companies currently carry that rating, and their credit metrics are somewhat distorted by recent transformational deals and one-time costs), there is a general correlation between lower leverage and stronger credit ratings (see Chart 1).
Another commonality among investment-grade chemical companies we rate is that we consider their financial risk profile significant or better. We generally define significant as weighted-average adjusted debt to EBITDA of between 3x and 4x, and funds from operations to adjusted debt of between 20% and 30%. Companies with significant (or better) financial risk profile typically have adjusted debt leverage below 4x (see Chart 2).
When we analyze a company's financial risk profile, we take into account a variety of leverage, cash flow, and coverage ratios (see Table 2).
|Cash Flow Leverage Analysis Ratios--Standard Volatility|
|--Core ratios--||--Supplementary coverage ratios--||--Supplementary payback ratios--|
|FFO/debt (%)||Debt/EBITDA (x)||FFO/cash interest (x)||EBITDA/interest (x)||CFO/debt (%)||FOCF/debt (%)||DCF/debt (%)|
|Minimal||60+||Less than 1.5||More than 13||More than 15||More than 50||40+||25+|
|Highly leveraged||Less than 12||Greater than 5||Less than 2||Less than 2||Less than 10||Less than 5||Less than 2|
|FFO--Funds from operations. CFO--Cash from operations. FOCF--Free operating cash flow. DCF--Discretionary cash flow. Source: S&P Global Ratings (“Criteria: Corporate Methodology,” published Nov. 13, 2013.)|
Our assessment of a company's financial risk profile is a key factor in determining the credit rating on a company, but other credit-related attributes help determine ratings as well. We also consider an issuer's competitive advantage, diversification, profitability, financial policy, and liquidity. As a result, several companies in the 'BB' category might have credit metrics on par with those in the 'BBB' category. However, they usually have key weaknesses in terms of business risk (such as lack of product or customer diversity or high volatility in their profitability).
2019 Brings Two Potential Rising Stars
We believe most issuers are motivated to achieve (or maintain) investment-grade ratings to facilitate access to capital markets, lower capital costs, and maintain favorable credit terms with suppliers. We expect issuers, lenders, and trade partners to remain keenly interested when the credit rating on a company has potential to move between the investment- and speculative-grade categories, not only in the U.S chemicals sector but also the broader global corporate credit market. We believe Huntsman Corp. and Olin Corp. could be upgraded to investment grade in 2019. Those potential actions would depend on both the underlying performance of the businesses and management financial policies regarding uses of cash and shareholder rewards. Although we do not foresee many crossovers in the North American chemicals sector over the next year, it is always possible for financial policy decisions or market events to lead to revised assumptions that could affect our view of credit quality. Furthermore, the preponderance of companies we currently rate in the 'BB' and 'BBB' category does lend itself to potential crossovers over the next few years.
- Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013
This report does not constitute a rating action.
|Primary Credit Analyst:||Michael P McConnell, New York + 1 (212) 438 0059;|
|Secondary Contact:||Daniel S Krauss, CFA, New York (1) 212-438-2641;|
|Research Assistant:||Julie M Tsang, New York|
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