TEXT - S&P revises Ferro Corp outlook to negative

Fri Nov 9, 2012 4:27pm EST

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Overview
     -- Ferro's earnings have deteriorated in recent quarters due to weak 
results in its electronic materials segment and continued weakness in Europe. 
     -- We are revising our outlook on Ferro to negative from stable. At the 
same time, we are affirming our ratings, including the 'B+' corporate credit 
rating, on the company.
     -- The negative outlook reflects the potential for ratings to move lower 
in the near term if operating results do not strengthen from subdued 2012 
levels.
 
Rating Action
On Nov. 9, 2012, Standard & Poor's Ratings Services revised its outlook on 
Ferro Corp. to negative from stable. At the same time, we affirmed all our 
ratings, including the 'B+' corporate credit rating, on the company. 

Rationale
The outlook revision follows the company's report of weak third quarter 
operating results and reflects our expectation that earnings will remain 
challenged over the near term. We have modified our initial expectation that 
earnings in the second half of 2012 would be in line with first half levels, 
and now believe that they will decline moderately and remain weak into 2013. 
The reduction in EBITDA reflects continued weakness in Europe (which 
represents roughly one-third of the company's revenues), and subdued demand in 
the electronic materials segment, particularly for the company's conductive 
pastes and powders used in solar panels. 

Given the continued economic uncertainty and reduced earnings expectations, we 
now believe that over the near term the key ratio of funds from operations 
(FFO)-to-total adjusted debt will remain modestly below the 15% that we 
consider appropriate for the current rating. Key underpinnings at the rating 
are the expectation that earnings will gradually improve in 2013 as Ferro 
undertakes additional cost cutting actions, and that the company will be able 
to maintain adequate liquidity, including sufficient cushion under financial 
covenants. In October, Ferro announced that it was exploring strategic options 
for its solar paste business, given the continued weakness and reduced outlook 
in this segment. We believe that if the company is able to divest this 
negative EBITDA segment, then the cushion under tight financial covenants 
would increase and help reduce some of the volatility inherent in the 
company's operating results moving forward.

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 $1.8 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 the 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 makes up more than 15% of revenues) 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 past year and a half, the company has been affected by a reduced 
amount of paste now being used in solar cells (thrifting). In addition, the 
solar industry has 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, tariffs imposed on Chinese solar manufacturers 
add further uncertainty to demand. At its peak, solar represented a sizeable 
portion of the electronic materials segment EBITDA and had significantly 
higher margins than the other segments. The company's overall EBITDA margins 
have meaningfully deteriorated in large part due to the solar decline; the 
last-12-month EBITDA margins were 5.9% as of Sept. 30, 2012, down from 12.1% 
for the same period ended September 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 meaningful drop in EBITDA over the past 
year, credit metrics have weakened significantly. The key ratio of 
FFO-to-total adjusted debt (adjusted for capitalized operating leases, and 
underfunded pension and other postretirement obligations) was 14% as of Sept. 
30, 2012, compared with 30% at the end of 2011. We believe management will 
remain prudent in regards to capital spending plans and acquisition activity, 
thereby maintaining a financial policy that supports the ratings.

Liquidity
We view Ferro's liquidity as "adequate." As of Sept. 30, 2012, the company had 
$25 million in cash and about $335 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 $335 million in 
collateral free lease lines with various financial institutions and did not 
have any cash on deposit as collateral as of Sept. 30, 2012. However, at 
certain difficult times in the past Ferro has been required to post cash 
collateral related to these leases, and this has meaningfully reduced the 
company's liquidity. Financial institutions can change the amount of cash 
collateral that is required from the company when the leases come up for 
renewal, and we continue to view this as a meaningful risk factor if the 
company's financial profile deteriorates. If the company is successful in 
exiting the solar segment, then its precious metals requirements would 
moderately decline.

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; 
     -- 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; and
     -- The company has generally prudent financial risk management.
 
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 mainly 
through revolver borrowings. In June 2012, the company temporarily amended its 
financial covenants to provide additional flexibility. Financial covenants now 
include a maximum leverage ratio of 4.25x for the fourth quarter of 2012, 
which steps down to 3.5x thereafter, as well as a maximum capital expenditure 
and minimum interest coverage covenant. The minimum interest coverage covenant 
is 2.75x in the fourth quarter of 2012, and 3.0x thereafter. Ferro eliminated 
the minimum fixed-charge coverage ratio, which was problematic, as it had 
deducted capital expenditures from EBITDA in the calculation. Our base case 
assumes the company will be able to maintain compliance with modest cushions, 
although a moderate improvement in 2013 earnings is needed to remain in 
compliance given the step downs. We expect that management will be proactive 
in seeking covenant relief should compliance with covenants become an issue 
over the near term.

Recovery analysis
Our issue-level rating on the company's $250 million senior unsecured notes is 
'B-' (two notches below the 'B+' corporate credit rating), and the recovery 
rating is '6', indicating our expectation of negligible (0% to 10%) recovery 
in the event of a payment default. Our issue-level rating on the $34 million 
senior convertible notes is 'B-' (two notches below the corporate credit 
rating), and the recovery rating is '6', indicating our expectation of 
negligible (0% to 10%) recovery in the event of a payment default. For the 
complete recovery analysis, see our recovery report on Ferro Corp., 
""here
=7330512&rev_id=4&sid=998532&sind=A&"," published on May 17, 2012, on 
RatingsDirect.

Outlook
The outlook is negative. Our base case assumes that earnings will improve 
modestly in 2013, albeit from very weak levels, as the company continues its 
ongoing cost cutting initiatives and could benefit from a potential 
divestiture of the negative EBITDA solar paste segment. However, we could 
lower the ratings in the near term if earnings remain at, or deteriorate from, 
subdued 2012 levels, due to continued weakness in Europe or challenging 
industry conditions. Based on our downside scenario, we could lower the 
ratings if revenues decline by 10%, and EBITDA margins remain at current 
levels. 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, EBITDA 
cushions under the covenants decline to about 10%, or if the financial 
institutions that Ferro leases its precious metals from, begin to require cash 
collateral, thus reducing liquidity.

We could consider an outlook revision to stable 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 
an outlook revision if EBITDA margins improve by 150 basis points or more from 
expected 2012 levels, coupled with a 5% increase in revenues. In such a 
scenario, we expect that FFO-to-total adjusted debt would consistently exceed 
15%. The company's end-market concentration in construction and electronics, 
which are cyclical and have discretionary demand characteristics, could limit 
the potential for an upgrade if the company does not take strategic actions to 
diversify and strengthen its portfolio.

Related Criteria And Research
     -- Key Credit Factors: Criteria For Rating Companies In The Global 
Commodity Chemicals Industry, Sept. 19, 2012
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
Sept. 18, 2012
 
Ratings List

Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
Ferro Corp.
 Corporate Credit Rating                B+/Negative        B+/Stable

Ratings Affirmed

Ferro Corp.
 Senior Unsecured                       B-                 
  Recovery rating                       6
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