TEXT-S&P cuts Martin Marietta Materials ratings to 'BBB'
Overview -- We believe near-term demand growth for U.S.-based aggregates producer Martin Marietta Materials Co. will remain sluggish, resulting in lower profits and credit measures that are more consistent with a lower rating during the next few years. -- In addition, Martin Marietta's willingness to assume greater debt leverage in an attempt to acquire Vulcan Materials Co. reflects somewhat more aggressive financial risk taking, in our view. -- We are lowering our ratings on Martin Marietta, including the corporate credit and senior unsecured debt ratings, to 'BBB' from 'BBB+'. All ratings were removed from CreditWatch negative. -- The stable outlook reflects our assessment that Martin Marietta's credit measures will remain in a relatively narrow range over the next two years as aggregates demand appears to have stabilized at current levels. Rating Action On Aug. 1, 2012, Standard & Poor's Ratings Services lowered its ratings, including its corporate credit and senior unsecured debt ratings, on Raleigh, N.C.-based Martin Marietta Materials Co. to 'BBB' from 'BBB+'. The outlook is stable. We removed all the ratings from CreditWatch were they were placed with negative implications on Dec. 13, 2011. Rationale The downgrade and CreditWatch removal reflects our expectation that aggregates demand in the U.S., driven largely by Federal and State infrastructure spending, commercial, and new home construction, will remain at steady, but historically low, volumes over the next two years. We expect this will result in credit measures for Martin Marietta remaining more consistent with a 'BBB' rating. In addition, the downgrade reflects Martin Marietta's willingness to assume greater financial risk as demonstrated by its recent bid, withdrawn as a result of a court order, to acquire larger competitor Vulcan Materials Co. (BB/Stable/--), which would have resulted in a significant increase in debt leverage. Our view of Martin's financial risk policy is consistent with that of a low investment-grade rating. Our ratings and outlook do not incorporate meaningful acquisition activity. However, we would reassess our ratings and outlook should Martin resume its bid for Vulcan Materials Co., when permitted, or if it pursued a similar sized acquisition or other business combination. Our 'BBB' corporate credit rating reflects our assessment of Martin's "strong" business risk marked by a well-established position in the highly fragmented U.S. aggregates industry, good operating margins, pricing stability, geographic sales diversity within the U.S., and consistently positive cash flows. These strengths are partially offset by participation in highly cyclical and competitive construction markets, exposure to volatile energy costs and ongoing low levels of U.S.-based construction activity. We view Martin's financial risk as "significant", reflecting good operating cash flow generation even through periods of low aggregates demand, adequate liquidity, and prospects for meaningfully strengthened earnings when U.S. construction markets fully recover. Offsetting these strengths are the risks of a somewhat more aggressive financial policy toward debt-financed acquisitions, still-weak construction markets, and cyclical demand for aggregates. The company derives more than 50% of its total aggregates volumes from highway and other public infrastructure projects, which is marked by consistent spending despite constrained state budgets. The recent enactment of a new 27-month Federal highway bill at close to current spending levels will likely provide more certainty for project funding over the next two years, but, in our view, will not result in any material increase in aggregates demand. We expect only modest growth in aggregates demand from the commercial and residential construction markets, which are less aggregates intensive than road and infrastructure repair and construction. Under our baseline scenario, we expect mid-single digit sales growth in 2012 and 5% sales growth in 2013. We expect EBITDA to improve to $400 million by 2013, compared with its current $$380 million to $390 million. Key assumptions to our baseline scenario include: -- Flat federal highway appropriations and only modest growth in other construction activity; -- Volume growth of 2% to 3% and similar growth in pricing in 2012; -- Low single digit price and volume increases in 2013; and -- Stable operating margins. Risks to our forecast included an unexpected decline in aggregates demand potentially caused by a recessionary pressures and a pull back in general construction activity in the U.S. Upside risks to our forecast could occur due to the high operating leverage in Martin Marietta's business. For example, we estimate that EBITDA could increase significantly to more than $500 million if volumes increased to the 175 million to 180 million ton range. This level would still be well below Martin Marietta's peak tonnage of about 205 million tons in 2006. However, given the current state of construction markets and Federal and State highway spending levels, we do not foresee this type of growth until 2015 or beyond. Based on our EBITDA assumptions, we expect Martin Marietta will post funds from operations (FFO) of about $250 million, resulting in FFO to debt of about 20%. In addition, we expect the company to maintain leverage (after adding back expenses associated with the failed Vulcan bid) at about 3.6x by the end of 2012. We consider these metrics to be more in-line with the 'BBB' rating given our view of its strong business risk profile. Assuming no debt funded acquisition or share repurchase activity, combined with modest debt reduction, we would expect leverage to decline to the 3.0x to 3.25x and FFO to debt to increase to about 25% by the end of 2013. Liquidity Our short-term rating on Martin Marietta is 'A-2', and we view the company's liquidity to be adequate. Our liquidity assessment is based on the following factors and assumptions: -- We expect the company's liquidity sources (including cash, funds from operations, and availability under credit facilities) over the next 24 months to exceed its uses by more than 1.2x. -- In our analysis, we assumed liquidity of about $650 million over the next 12 months, consisting of cash, FFO and availability under its credit facilities. We estimate total uses in 2012 of approximately $300 million, including about $150 million in capital expenditures and $75 million in dividends. -- Near-term debt maturities are minimal until the company's revolving credit and term loan facility matures in 2015. -- Even if EBITDA declines by 15%, we believe sources would exceed uses by 1.2x. Martin Marietta's credit agreement includes a total leverage covenant of 3.95x trailing-12-month EBITDA, with the ratio stepping down to 3.75 on Sept. 30, 2012, and returning to its prior level of 3.5x on Dec. 31, 2012. We expect Martin to maintain at least 15% EBITDA cushion in this covenant. For 2012, we expect Martin Marietta will produce cash flow from operations of about $275 million for 2012, which is more than sufficient to fund capital expenditures of about $150 million and dividends of about $75 million annually. We expect similar cash flow, capital expenditures, and dividend levels for 2013. We do not expect any meaningful share repurchase activity until markets recover more fully. Outlook The rating outlook is stable. We expect Martin Marietta to maintain credit measures which support the 'BBB' rating despite low levels of aggregates demand given Martin's healthy operating margins and good cash flow. We believe financial results for year end 2012, adjusted for the non-recurring expenses of the attempted Vulcan acquisition, will result in adjusted leverage of about 3.6x and FFO to debt of about 20%. For 2013, we expect Martin Marietta will dedicate free cash flow to reduce debt balances. As a result, even in a scenario of flat volumes, total leverage would improve to between 3.0x and 3.25x. Our rating does not incorporate a renewed bid for Vulcan Materials once Martin is permitted to do so. However, should Martin undertake a renewed effort to acquire Vulcan (or another similarly sized acquisition), it is likely we would place the ratings under review for further downgrades. We could also take a negative rating action if earnings deteriorate materially from current levels, causing credit measures to worsen with adjusted leverage exceeding 4x on a sustained basis. This could occur if volumes unexpectedly fell below the 110 million ton level and fuel prices increased substantially from current levels, causing adjusted EBITDA to fall to below $325 million. Given our view of Martin's willingness to assume more financial risk, and that aggregate volumes are not likely to increase substantially over the next two years, we would view a positive rating action as unlikely in the near term. Also, for an upgrade to occur, our assessment of Martin's financial risk profile would need to be consistent with a higher investment grade rating, requiring prudent levels of leverage with regard to any substantial acquisition or future share repurchase activity. However, assuming a more conservative financial risk profile, we could consider an upgrade if Martin's sales recovered more quickly than expected resulting in increased size and operating income enabling Martin Marietta to reduce total leverage to under 2.5x on a sustained basis. For this to occur, we think Martin's aggregates volumes would have to exceed 175 million tons on an annual basis, which, along with low single-digit pricing growth, would result in EBITDA in excess of $550 million. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Key Credit Factors: Business And Financial Risks In The Global Building Products And Materials Industry, Nov. 19, 2008 -- Corporate Ratings Criteria 2008, published April 15, 2008. -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; Off CreditWatch; Outlook Stable To From Martin Marietta Materials Inc. Corporate Credit Rating BBB/Stable/A-2 BBB+/Watch Neg/A-2 Senior Unsecured BBB BBB+/Watch Neg Rating Affirmed; Off CreditWatch To From Martin Marietta Materials Inc. Commercial Paper A-2 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. 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