TEXT-S&P cuts Ferro Corp rating to 'B+'

Mon Jul 30, 2012 2:28pm EDT

Overview
     -- Operating results for Ohio-based chemicals producer Ferro Corp.  
 have deteriorated in recent quarters, and the company has significantly
lowered its earnings guidance for 2012. 
     -- We lowered our corporate credit rating on Ferro to 'B+' from 'BB-' and 
lowered all our issue-level ratings by one notch.
     -- The stable outlook reflects our expectation that, despite a 
significant reduction in 2012 EBITDA, the company will be able to maintain 
adequate liquidity and a financial profile consistent with the ratings.

Rating Action
On July 30, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on Ferro Corp. to 'B+' from 'BB-'. We also lowered the 
issue-level ratings on the company's senior unsecured debt to 'B-' from 'B'. 
The '6' recovery rating, which remains unchanged, reflects our expectation for 
negligible (0% to 10%) recovery in the event of a payment default. The outlook 
is stable.

Rationale
The downgrade follows the company's announcement that it has significantly 
lowered its earnings guidance for 2012. The reduction in earnings expectations 
reflect the continued weakness in Europe (which represents roughly one-third 
of the company's revenues), subdued demand in the electronic materials 
segment, particularly for the company's conductive pastes used in solar 
panels, and increased pension expense. We modified our initial expectation 
that earnings would moderately grow in the second half of the year, to now 
being in line with first-half levels. Given the continued economic uncertainty 
and reduced earnings expectations, we now believe that the key ratio of funds 
from operations (FFO) to total adjusted debt will fail to meet our previous 
expectations of 20%, a level we had considered appropriate for the 'BB-' 
rating. Based on our scenario forecasts for moderately lower cash flows in 
2012, we expect this ratio will decline to about 15%, which we consider in 
line with an "aggressive" financial risk profile and appropriate for the 
current rating. Accordingly, we revised our assessment of the financial risk 
profile to "aggressive" from "significant".

The ratings on Ohio-based Ferro Corp. reflect our assessment of the company's 
business risk profile as "weak" and financial risk profile as "aggressive." 
With annual sales of $1.9 billion, the company produces a variety of 
performance materials and chemicals for use, primarily in the electronics, 
construction, appliances, automotive, and household furnishings end markets. 
Ferro operates in six business segments: electronic materials, color and glass 
performance materials (which include high-quality glazes, enamels, pigments, 
and dinnerware decoration colors), performance coatings (which include tile 
coatings and porcelain enamel for appliances and cookware), polymer additives, 
specialty plastics, and pharmaceuticals.

Ferro remains vulnerable to cost fluctuations for its raw materials and has 
significant exposure to residential and commercial construction and 
electronics end markets. Many of the company's products are discretionary 
purchases, which renders their demand highly sensitive to extended cyclical 
downturns. In addition, profitability in some business segments (such as 
polymer additives, which make up about 15% of sales) is suffering because of 
commodity-like and highly competitive markets. Partially offsetting these 
weaknesses are the company's leading market positions in some of its segments, 
a diverse portfolio of performance materials and chemicals, geographic and 
customer diversification, and an improved cost structure. Its top 10 customers 
account for about 20% of sales, and it generates more than 50% of revenues 
outside of the U.S. (although a significant portion of that is derived from 
the weak European market). 

Over the last year, the company has been affected by a reduced amount of paste 
now being used in solar cells (thrifting). In addition, the solar industry has 
also felt the effects of reductions in government subsidies for solar use in 
parts of Europe, and increased solar panel competition, which led to 
production overcapacities, excess inventories of solar panels and rapid price 
declines. Additionally, recent tariffs imposed on Chinese solar manufacturers 
add further uncertainty to near-term demand. Given the expectation that this 
segment will remain weak over at least the near term, the company's efforts to 
secure additional product qualifications and increase share with Asian Tier 1 
customers will remain key to improving earnings in the electronic materials 
segment. At its peak, solar represented a sizeable portion of the company's 
EBITDA and had significantly higher margins than the other segments. The 
company's margins have deteriorated with the solar decline; the last-12-month 
EBITDA margins were 7.4% as of June 30, 2012, down from 12.7% for the same 
period ended June 2011.  

Debt reduction in 2009 and 2010 (in part with proceeds from a 2009 equity 
issuance), the recovery of cash collateral relating to the company's precious 
metal leases, and the resulting significant reduction in interest expense all 
contributed to Ferro's improved financial risk profile when compared with 
2009. However, as a result of the significant drop in EBITDA over the past 
year, credit metrics have weakened--a trend we expect to continue this year. 
The ratio of FFO to total adjusted debt (adjusted for capitalized operating 
leases, and underfunded pension and other postretirement obligations) was 23% 
as of June 30, 2012, compared with 30% at the end of 2011. We believe 
management will remain prudent in its capital spending plans and any potential 
acquisitions or shareholder rewards, thereby maintaining a financial policy 
that support our ratings.

Liquidity
We view Ferro's liquidity as "adequate." As of June 30, 2012, the company had 
$25 million in cash and about $341 million available under its $350 million 
revolving credit facility maturing in August 2015. The company also has a $50 
million 364-day receivables securitization facility expiring in May 2013. 
Ferro uses precious metals in the production of some of its products, 
primarily silver for electronic materials products. It has about $350 million 
in collateral free lease lines and did not have any cash on deposit as 
collateral as of June 30, 2012.

We base our liquidity assessment on the following factors and expectations:
     -- Sources of cash will exceed 1.2x of cash usage during the next 12 to 
18 months; 
     -- Sources will remain positive even in the event of a 20% EBITDA 
decline; 
     -- Compliance with financial covenants could survive a 15% drop in 
EBITDA; and
     -- Ferro would likely be able to absorb low-probability shocks based on 
available liquidity. We believe the company's flexibility to lower capital 
spending or sell assets should supplement liquidity.

Debt maturities are limited for the next several years, with the next upcoming 
maturity consisting of the remaining $34 million of convertible senior notes 
due Aug. 15, 2013. We expect that the company will repay these notes through a 
combination of free cash flow and revolver borrowings. In June 2012, the 
company amended its financial covenants to provide additional flexibility. 
Financial covenants now include a maximum leverage ratio of 4.25x in 2012 and 
3.5x thereafter, as well as a maximum capital expenditure and minimum interest 
coverage covenant. The minimum interest coverage covenant is 2.5x in the third 
quarter of 2012, 2.75x in the fourth quarter, and 3.0x thereafter. Ferro 
eliminated the minimum fixed-charge coverage ratio, which we believe was 
problematic, as it had deducted capital expenditures from EBITDA in the 
calculation. 

Recovery analysis
For the complete recovery analysis, see our recovery report on Ferro Corp., 
Ferro Corp.'s Recovery Rating Profile, published on May 17, 2012, on 
RatingsDirect.

Outlook
The outlook is stable. Our base case assumes a significant drop in 2012 
EBITDA, resulting from depressed demand for solar pastes, coupled with 
continuing sluggish demand for residential and commercial building and 
renovation, particularly in Europe. We expect that earnings will improve 
modestly in 2013, albeit from very weak levels, as the company should benefit 
from recent cost cutting initiatives. Based on our scenario forecasts, we 
believe that 2012 free operating cash flow will be neutral, based on our 
expectations that reduced capital expenditures and lower working capital needs 
will offset lower earnings.

We could lower the ratings within the next 12 months if industry conditions or 
the company's operating performance are below our expectations. This could 
occur if the company is unable to successfully improve its position in the 
Asian solar market, or if fierce competition continues to keep pricing down. 
Based on our downside scenario, we could lower the ratings if revenues decline 
by 15% and EBITDA margins decrease by 100 basis points or more below our 
expectations. In such a scenario, FFO to total adjusted debt would decrease to 
below 12%. We could also lower the ratings if free cash flow turns negative, 
or if EBITDA cushions under the covenants decline to about 10%.

We could consider a one-notch upgrade if the macroeconomic outlook 
strengthens, operating results stabilize, and we gain confidence that EBITDA 
will moderately improve from weak 2012 levels. Specifically, we could consider 
a modest upgrade if EBITDA margins improve by 150 basis points or more, 
coupled with a 5% increase in revenues. In such a scenario, we expect that FFO 
to total adjusted debt would increase to above 20%. The company's end-market 
concentration in construction and electronics, which are cyclical and have 
discretionary demand characteristics, could limit further upgrade potential if 
the company does not take strategic actions to diversify and strengthen its 
portfolio.

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
May 27, 2009 
     -- Key Credit Factors: Methodology And Assumptions On Risks In The 
Packaging Industry, Dec. 4, 2008
Ratings List
Ratings Lowered

Ferro Corp.
                                        To                 From
 Corporate credit rating                B+/Stable/--       BB-/Stable/--
 Senior unsecured                       B-                 B
 Recovery rating                        6                  6
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