TEXT-S&P revises Xerium Technologies outlook to negative
Overview -- U.S.-based Xerium Technologies Inc.'s operating performance has weakened as a result of lower demand from European papermaking markets, and we believe this softness is likely to continue over the next 12 months. -- We are affirming our ratings on the company, including the 'B' corporate credit rating. -- At the same time, we are revising the outlook to negative from stable. -- The negative outlook reflects our expectation that end markets and operating performance are likely to remain weak in the near term. Rating Action On Nov. 20, 2012, Standard & Poor's Ratings Services revised its outlook on Raleigh, N.C.-based paper product manufacturer Xerium Technologies Inc.'s corporate credit rating to negative from stable. At the same time, we affirmed the ratings on the company, including the 'B' corporate credit rating. Rationale The negative outlook reflects our expectation that weak end markets, especially in Europe where Xerium generates about 30% of its revenues, are likely to continue to pressure Xerium's operating performance in 2013. We believe volumes are tied to GDP growth, and we expect GDP in the eurozone to contract 0.8% in 2012 and be flat in 2013. Despite cost reductions and relatively better demand in Asia and America, the company may not be able to maintain a comfortable level of headroom over its financial covenants if European markets do not stabilize. Our forecast also assumes: -- GDP growth in the U.S. of 2.1% in 2012 and 2.3% in 2013; -- Mid-single-digit contraction in Xerium's top line in 2012 and no growth in 2013; -- High-teens EBITDA margin; and -- Annual capital expenditures of about $30 million. The ratings also reflect our view of Xerium's "weak" business risk profile and "highly leveraged" financial risk profile. The business risk profile takes into account the company's continued presence in the cyclical and competitive market for papermaking products, limited end-user industry diversification, and our expectation that structurally weak medium-term demand in mature markets will likely continue to pressure prices for the company's products. In our view, Xerium's relatively variable cost structure, sound margins, and fair geographic diversification partly offset these weaknesses. Xerium's geographic diversification should enable it to benefit from more positive industry fundamentals in emerging markets. The company generated revenues of $550 million in the 12 months ended Sept. 30, 2012. Xerium operates in two business segments: clothing, in the form of synthetic textile belts that transport paper through papermaking machines, and roll covers, which provide covering surface for large steel cylinders between which paper travels. Clothing represents roughly 65% of revenue, and roll covers make up the remainder. These consumables will continue to play key roles in converting raw material into paper, and we expect customers to continue to prefer local, long-standing suppliers that they believe are reliable. The company has indicated that it derives about two-thirds of its sales from products customers use in the production of high-growth paper grades such as tissue, containerboard, and specialty paper. Newsprint and printing paper grades represent the remaining sales; these are experiencing low growth or contraction. We expect the long-term shift of global production to Asia to continue, and, in our view, this could cause production volumes in North America and Europe to remain subdued. As a result, we believe pricing, although not the key buying decision (given the product's critical nature and its low cost compared with the total cost of papermaking), will remain highly competitive in these markets. Xerium derives about 28% of its sales from Asia-Pacific and South America, and it should benefit from higher growth rates in these regions. However, the company does not currently have paper-machine clothing production facilities in China, and this could constrain its ability to capitalize on growth trends in this large market. Xerium's adjusted operating margin (before depreciation and amortization), at about 17% in the 12 months ended Sept. 30, 2012, has declined from about 21% last year because of lower volumes in Europe. In our view, paper mill closures, industry consolidation, and limited pricing power are likely to continue to pressure Xerium's margins. However, we believe the company's restructuring actions should enable it to prevent further decline in margins. The company held margins in the high teens when revenue contracted by more than 20% in 2009. The capital structure reflects what we consider to be a highly leveraged financial risk profile. Leverage, measured by adjusted total debt to EBITDA, was about 5.5x as of Sept. 30, 2012. For the rating, we expect total debt to EBITDA of 5x-6x. In our view, stable operating margins should contribute cash flow sufficient enough to cover capital expenditures and working capital requirements and also to support modest debt reduction. The ratings do not account for large, debt-financed acquisitions, and such acquisitions could result in our reviewing the ratings for a possible downgrade of the company. Liquidity We believe Xerium has adequate sources of liquidity to cover its needs in the near term, even if EBITDA declines unexpectedly. The company has minimal maturities over the intermediate term. Our assessment of Xerium's liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources of liquidity, including cash and facility availability, to exceed its uses by 1.2x or more over the next 12 to 18 months. -- We expect net sources to remain positive, even if EBITDA declines more than 15%. -- We believe the company has the flexibility to reduce capital expenditures by about $15 million. -- We expect management to anticipate potential setbacks and take necessary actions to ensure adequate liquidity. Liquidity sources include our expectation of about $20 million in discretionary cash flow in 2012 and 2013, access to its $30 million revolving credit facility, and sufficient cash to cover operating needs and to collateralize letters of credit. Uses of liquidity include roughly $30 million in capital expenditures and minimal debt amortization. Recovery analysis We rate Xerium's senior secured credit facility 'BB-', with a recovery rating of '1', indicating our expectation of a very high (90% to 100%) recovery in a payment default scenario. We rate the company's unsecured notes 'B', with a recovery rating of '4', indicating our expectation of average (30% to 50%) recovery in a payment default. (See our recovery report on Xerium Technologies Inc., published May 30, 2012 on RatingsDirect.) Outlook The outlook is negative. We could lower the ratings if EBITDA declines and the company does not reduce its debt, which could result in limited EBITDA headroom over its financial covenants. Factors that could contribute to such a scenario would be continued global economic weakness, increased pricing pressures, and adverse foreign exchange movements. We could revise the outlook to stable if operations stabilize and we expect the company to maintain headroom of at least 15% over its covenants. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed; Outlook To Negative To From Xerium Technologies Inc. Corporate Credit Rating B/Negative/-- B/Stable/-- Ratings Affirmed Xerium Technologies Inc. Senior Secured BB- Recovery Rating 1 Senior Unsecured B Recovery Rating 4 Xerium Technologies Ltd. Senior Secured BB- Recovery Rating 1 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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