TEXT-S&P cuts Harsco Corp ratings to 'BBB/A-3'
March 29 - Overview -- U.S.-based Harsco Corp. faces continued pressures in restoring its profitability and cash flows, and we believe its credit measures are unlikely to recover adequately in the next two years. -- We are lowering our long-term and short-term ratings on the company by one notch, to 'BBB' and 'A-3' respectively. -- The negative outlook reflects the possibility of a further downgrade if the company's ongoing restructuring initiatives do not yield expected margin improvements and if cash flow protection metrics do not improve over the next 18 months. Rating Action On March 29, 2012, Standard & Poor's Ratings Services lowered its long-term ratings on Harsco Corp., including the corporate credit rating, by one notch to 'BBB' from 'BBB+'. The outlook is negative. At the same time we lowered the short-term and commercial paper ratings to 'A-3' from 'A-2'. We removed all ratings from CreditWatch, where we had placed them with negative implications on Jan. 13, 2012. Rationale The downgrade and negative outlook reflect Harsco Corp.'s delayed progress in restoring its historical profitability, its weakened cash flow protection measures, and our expectation that the company is unlikely to restore ratios adequate for the previous rating over the next two years. While we do expect some profitability improvement this year and higher cash flows in 2013, to achieve this the company will need to execute on its ongoing restructuring plans. We continue to view the company's business risk profile as "satisfactory" and its financial profile as "intermediate." We expect the company will continue to benefit from its well-established positions in its key markets and its good geographic diversity. However, high fragmentation, competitive pricing conditions, and high fixed-capital requirements to support growth offset these positives. The rating incorporates our expectation that revenues could experience a mid-single-digit decline in 2012 as certain of Harsco's key markets, such as construction in Europe and global steel production, remain soft and the company exits certain underperforming contracts. Restructuring actions should buffer the impact on profitability from lower volumes, but these are subject to some execution risk in our view. We believe that free cash flow could remain negligible or be slightly negative in 2012 because of cash restructuring costs, but that it could approach $100 million in 2013. Recent management changes could alter the company's future capital spending strategy, but capital requirements to support growth will likely remain significant. Harsco serves a diversified industrial base. Its infrastructure segment provides construction scaffolding and forming equipment and services, the metals and minerals segment provides metal reclamation and specialized steel mill services, the rail segment provides railway maintenance-of-way equipment and services, and the industrial segment manufactures a variety of products including those for heat transfer-related applications. Services and equipment manufacturing represent about 80% and 20% of revenues, respectively. Nonresidential construction activity, global steel and industrial production, and rail infrastructure maintenance spending all influence demand. Harsco is one of the largest players in its markets and benefits from its strong engineering capabilities and a global footprint. However, these markets are cyclical, and competition is highly fragmented globally (particularly in commercial construction). These factors add risks to its infrastructure and metals and minerals segments, which operate with high fixed costs, leading to fairly high operating leverage. Strong price competition, especially in construction markets, when market conditions are weak add to profit volatility. Such instances can offset the company's emphasis on higher-margin industrial services in its infrastructure segment. The company gains some stability from the long-term contracts that provide a majority of revenues in the metals and minerals segment, its relatively flexible capital spending during a downcycle, and its higher-margin and more-stable rail and industrial businesses. Although global steel and industrial markets have recovered, business conditions in the company's late-cycle infrastructure segment (exposed to nonresidential construction) remain difficult. Low utilization and rental rates, especially in Europe, continue to cause operating losses. Ongoing restructuring initiatives have yet to restore the profitability of the infrastructure segment. Opportunities from new contracts and partnerships in the metal and minerals segment could help accelerate growth, but profitability remains correlated with global steel production volumes. And we believe Harsco's continued use of capital to support long-term contracts in the metal business could limit free cash flow generation for the next few years. Our assessment of the company's intermediate financial risk profile reflects management's financial policy of maintaining moderate debt leverage. This is offset by the decline in cash flow protection metrics caused by weakened operating performance as well as higher pension liabilities. At the end of 2011, funds from operations (FFO) to total debt was just greater than 30%, and we expect some weakening in 2012 before a recovery toward 35% in 2013. Achieving these measures would be consistent with our expectations for the 'BBB' rating, provided that the company also strengthens its free cash flow generation, such that FOCF to total debt recovers towards 10%. Liquidity Our short-term rating on Harsco is 'A-3', and we assess the company's liquidity as "adequate." We believe that the company's sources of liquidity will exceed its uses by 1.2x or more over the next 12 to 18 months and that the company will have adequate sources of liquidity to cover its needs in the near term, even in the event EBITDA declines more than 15%. Liquidity sources include our expectation for about $300 million of operating cash flow in 2012 after cash restructuring expenses. The company also had about $120 million of cash on hand as of Dec. 31, 2011, and ample availability under a $525 million credit facility that expires in 2017. The revolver provides backup liquidity to Harsco's commercial paper (CP) program. Financial covenants (including a maximum debt to capital ratio of 60% and minimum interest coverage ratio of 3x) govern availability under the facilities. The company has adequate headroom over these requirements, and we expect this will continue. Liquidity uses includes our expectation of about $300 million in capital expenditures in 2012 and an annual dividend payout of about $70 million. Short-term CP borrowings amounted to about $40 million at the end of fiscal 2011. Other debt maturities include $150 million of notes due in September 2013 and $250 million due in October 2015. Outlook The outlook is negative. We could lower the rating if profitability does not improve this year or if heavy capital spending with limited or uncertain top and bottom line benefits continues to depress free cash flow generation. In particular, credit protection measures would likely remain subpar for the rating if the company fails achieve break-even profitability in its infrastructure segment and total operating margins remain less than 7% this year, or if free operating cash flow appears likely to remain less than $75 million in 2013. We could revise the outlook to stable if the company appears to be on track to achieve our baseline ratio expectations in 2013. Under our baseline scenario, we expect adjusted total debt to EBITDA will be about 2.4x (excluding restructuring expenses) and FFO to total debt will be just under 30% in 2012, subsequently recovering to 2.2x and more than 35%, respectively, in 2013. FOCF to debt should recover to about 7%-8% in 2013. This is based on the following assumptions: -- Mid-single-digit revenue decline in 2012, as the end of certain contracts and still-soft metals and construction markets offset modestly positive growth in the rail and industrial segments, followed by revenue expansion on pace with global GDP growth in 2013; -- A return to break-even operating profits in the infrastructure segment and total operating margins (excluding restructuring costs) improving to 7% or more in 2012; -- Neutral free cash flow generation in 2012 and about $100 million in 2013, based on about $300 million of annual capital expenditures. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Lowered, Removed From CreditWatch To From Harsco Corp. Corporate credit rating BBB/Negative/A-3 BBB+/Watch Neg/A-2 Senior unsecured BBB BBB+/Watch Neg Commercial paper A-3 A-2/Watch Neg Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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