TEXT-S&P revises Owens-Illinois outlook to stable from negative
Overview -- Credit measures for Owens-Illinois Inc. have maintained an improving trend, and the company is committed to further debt reduction. -- We are revising our outlook to stable from negative and affirming all existing ratings, including our 'BB+' corporate credit rating. -- The stable outlook reflects our view that gradually improving operating results and continued debt reduction will support improved credit measures. Rating Action On Sept. 27, 2012, Standard & Poor's Ratings Services revised its outlook on Perrysburg, Ohio-based-Owens-Illinois Inc. to stable from negative. At the same time, we affirmed all existing ratings on the company, including our 'BB+' corporate credit rating. Rationale The outlook revision reflects Owens-Illinois' improved earnings in the first half of 2012, and ongoing debt reduction. Credit measures have improved over the past year, with funds from operations (FFO)-to-total adjusted debt near 19% at June 30, 2012, compared with 15% at June 30, 2011. We expect FFO-to-total adjusted debt to continue to gradually improve in 2013. The company expects earnings in the second half of 2012 to be affected by challenging economic conditions in Europe. However, expected free cash generation remains solid at $250 million in 2012, which it will use to reduce debt. While challenging economic conditions in Europe remain a concern, the company's earnings and cash flow protection measures should benefit from demand growth in South America and Asia and relatively flat to slightly improving volumes in North America. Standard & Poor's Ratings Services' ratings on Owens-Illinois reflect the company's "satisfactory" business risk profile and "significant" financial risk profile. With annual sales of $7.4 billion, Owens-Illinois is the world's largest manufacturer of glass containers, with leading market positions in most regions. In 2011, 74% of its sales were outside of North America. The company produces a wide array of glass containers for beer, liquor, wine, food, tea, fruit juices, and other nonalcoholic beverages. Credit quality benefits from the company's long-standing relationships with food and beverage customers, and it has annual or multiyear supply contracts with many of them. Glass remains the packaging of choice for popular upscale iced teas, beers, wines, and certain beverages and foods that rely on its superior marketing image and preservative qualities (by keeping out oxygen). Earnings for first six months of 2012 improved over the prior year as higher pricing offset the impact of cost inflation, and enhanced manufacturing and supply chain performance offset the impact of sales volume declines. Specifically, shipments of glass containers declined by 6% in the second quarter of 2012, compared with the same period in 2011, driven mainly by lower wine bottle sales in Southern Europe. In 2011, operating earnings were adversely affected by inflation of energy and other costs outpacing selling price increases, production and supply chain issues in North America, and a significant drop in Australian volumes for wine and beer. We expect Owens-Illinois' volumes to gradually improve in 2013, and price increases will offset raw material (mainly soda ash) and energy costs inflation. EBITDA margins have improved to 18% from 16% in 2011, and pretax return on capital is about 12%. During the past few years, Owens-Illinois has lowered its costs by shutting down excess capacity and amending contract terms to hasten the pass-through of energy cost changes in North America. Continued debt reduction should support further improvement to the company's credit measures. The key FFO-to-total adjusted debt ratio was about 19% as of June 30, 2012, and near our target range of 20% to 25% for the current ratings. As of June 30, 2012, total adjusted debt was about $5.7 billion. (We adjust debt to include $864 million representing our estimate of post-tax asbestos-related liabilities during the next 10 years, $684 million in post-tax underfunded postretirement liabilities, and $167 million in capitalized operating leases.) The company's asbestos-related liabilities, which stem from a business it exited in 1958, represent a moderate ongoing risk factor. Owens-Illinois' reserve for future asbestos-related costs reflects its estimated liability for approximately three years. The company expects to conduct an annual review of its asbestos-related liabilities and costs, and it anticipates that extending its estimation period by one year (to maintain a three-year estimated liability) each year will result in an annual charge. The reserve totaled $471 million as of year-end 2011. The number of pending asbestos-related lawsuits has been declining during the past few years. Asbestos-related cash payments have also been declining but remain substantial ($170 million in 2011, with the company expecting $165 million in 2012). Liquidity We regard Owens-Illinois' liquidity as "adequate." As of June 20, 2012, the company had $336 million of cash and $807 million of availability under its $900 million revolving credit facility maturing in 2016. In addition, the company has a EUR280 million European accounts receivable securitization program maturing in September 2016 subject to annual renewal of backup credit lines. Our liquidity assessment incorporates the following expectations and observations: -- We expect the company's sources of liquidity, including cash and facility availability, to exceed its uses by more than 1.2x during the next 12 months. -- We expect net sources to remain positive, even in the event that EBITDA declines by up to 20%. -- We expect the company to maintain an EBITDA cushion of more than 15% under the leverage covenant in its credit facility. -- We expect asbestos-related outlays, which totaled $170 million in 2011, to continue declining slightly in future years. -- Management currently expects capital expenditures to total $350 million in 2012. -- Debt maturities are moderate, with $76 million due in 2012, $129 million in 2013, and $206 million in 2014. Financial covenants include a maximum leverage covenant of 4x, and the actual ratio was 2.8x as of June 30, 2012. Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Owens-Illinois to be published shortly after this article. Outlook The outlook is stable. Credit measures have improved near appropriate levels, and we believe that management's actions to improve operating efficiency and continued focus on debt reduction should offset weak demand trends in Europe. We believe that financial policies are prudent and that management remains committed to lowering debt leverage, such that FFO-to-total adjusted debt can be sustained in the appropriate 20% to 25% range. We could lower the ratings slightly if credit metrics deteriorated such that FFO-to-total adjusted debt declined to or below 15% with no prospects for recovery. Based on our scenario forecasts, this could occur if the company is unable to pass on higher costs to customers in a timely fashion or if economic weakness materially depresses demand. This could cause volume to decline and EBITDA margins to decline below 16%. We could also lower the ratings if the company pursues debt-financed acquisitions, which cause deterioration in credit measures. While not expected at this time, we could raise the ratings if improved earnings and debt reduction resulted in FFO-to-total adjusted debt improve to 30% on a sustained basis. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Key Credit Factors: Methodology And Assumptions On Risks In The Packaging Industry, Dec. 4, 2008 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Owens-Illinois Inc. Owens Illinois Group Inc. Corporate Credit Rating BB+/Stable/-- BB+/Negative/-- Ratings Affirmed Owens-Illinois Inc. Senior Unsecured BB- Recovery rating 6 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. 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