Nov 27 -
Summary analysis -- Kaiser Aluminum Corp. ------------------------- 27-Nov-2012
CREDIT RATING: BB-/Stable/-- Country: United States
Primary SIC: Primary aluminum
Mult. CUSIP6: 483007
Credit Rating History:
Local currency Foreign currency
14-May-2012 BB-/-- BB-/--
22-Sep-1997 NR/-- NR/--
Standard & Poor's Rating Services' ratings on Foothill Ranch, Calif.-based Kaiser Aluminum Corp. reflects our view of the company's "weak" business risk and its "significant" financial risk. Our weak business risk assessment is based on the company's relatively small size and scope, exposure to the highly competitive and cyclical aluminum products industry, and relatively thin operating margins. These weaknesses are offset by its focus on niche downstream markets with improving industry fundamentals, a relatively conservative financial policy, and "strong" liquidity position.
Our baseline scenario anticipates that Kaiser's profitability will improve in 2012 and into 2013 as a result of steady end-market demand as the domestic economy gradually strengthens. We expect the company's aerospace and automotive segments, which constitute a majority of value-added revenue, to benefit from positive market dynamics in each of those segments. These include the high backlog of airplane builds, which Standard & Poor's estimates at seven to eight years, which should translate into increased orders. Growing aluminum content in automotives to improve fuel efficiency should also boost results. Standard & Poor's economists estimate unit sales of light vehicles domestically will rise 13% and 7% in 2012 and 2013, respectively.
As a result, we expect Kaiser's revenues to grow 10% or more in 2012 and 2013, given our assumption for a modest increase in shipments and stronger pricing in key end-markets. We also estimate that the company will generate between $150 and $200 million in EBITDA during both years. We expect funds from operations (FFO) to debt of 40% to 50% each year, and debt to EBITDA of between 2x and 2.5x, metrics we would consider to be good for the rating, considering our view of the company's weak business risk profile. However, Kaiser's revenues and profitability are tied to the cyclical aluminum products industry, and thus, results can be volatile. Risks to our forecast include a global economic recession that could lead to a downturn in aerospace and automotive production.
Kaiser''s primary line of business is the production of semifabricated specialty aluminum products for global markets. Kaiser focuses on highly engineered products for the aerospace and high strength, general engineering, automotive, and other industrial end market applications, including rolled, extruded, and drawn aluminum products. The company operates 11 production facilities in the U.S. and one in Canada; many of Kaiser's competitors are larger and more geographically diverse.
Kaiser manages the risk of fluctuations in the price of primary aluminum through a combination of pricing policies, internal hedging, and financial derivatives. The company's three pricing mechanisms include spot price, in which customers pay a product price that incorporates the spot of primary aluminum in effect at the time of shipment; index-based price, in which customers pay a product price that incorporates an index-based price for primary aluminum; and firm price, in which customers pay a previously agreed upon fixed price. In both spot and index-based pricing, Kaiser is able to pass metal price risk to the customer; in firm pricing, Kaiser uses back-to-back hedge contracts such that the company attempts to remain neutral to metal prices, which reduces volatility in profitability.
In our view, Kaiser's liquidity position is strong. Our view of the company's liquidity profile includes:
-- An expectation that liquidity sources (including the company's $300 million asset-based revolving credit facility) will exceed uses by at least 1.5x over the next one to two years.
-- An expectation that liquidity sources will continue to exceed uses, even if EBITDA were to decline by up to 30%.
-- An expectation that the company would continue to exceed the availability threshold under its credit facility, even with a 30% drop in EBITDA.
Sources of liquidity include $258.1 million of borrowing capacity under a $300 million ABL revolving credit facility that matures in 2016. As of Sept. 30, 2012, there were no borrowings and $6.7 million of letters of credit outstanding. Availability under the ABL facility is subject to a borrowing base of eligible accounts receivables and inventory, which will fluctuate throughout the year due to seasonal working capital changes. We do not think the company will encounter any financial covenant issues based on our operating assumptions, as a fixed-charge covenant is applied only if availability under the credit facilities falls below $30 million. Given our projections, we do not expect Kaiser to trigger the fixed-charge covenant. Kaiser also had about $255 million in cash and cash equivalents as of Sept. 30, 2012.
We expect working capital to be a modest use of cash in 2012 and 2013, and for the company to generate between $50 million and $100 million in free operating cash flow each year, given capital expenditures of $60 million to $70 million to fund plant expansions. We also expect liquidity to remain strong should the company decide to pursue dividends or share repurchases. The nearest debt maturity does not occur until 2015, when its $175 million convertible notes mature.
The rating on Kaiser's senior unsecured notes is 'BB-', the same as the corporate credit rating, with a recovery rating of '3', indicating our expectation for meaningful (50%- 70%) recovery in the event of a payment default. (For the complete recovery analysis, see our recovery report on Kaiser, published May 16, 2012, on RatingsDirect.)
The stable outlook reflects our view that Kaiser's profitability will improve in 2013 as a result of better end-market demand, particularly for the aerospace and high-strength segment, and a gradually improving domestic economy. We expect Kaiser to generate between $150 million to $200 million in EBITDA in 2012 and 2013, resulting in debt-to-EBITDA of between 2x and 2.5x, and FFO to debt of 40% to 50%. We also expect liquidity to remain strong to finance organic expansion and any acquisitions the company may pursue. Although we expect credit metrics will be good for our view of its significant financial risk profile, Kaiser's revenues and profitability are tied to the cyclical aluminum products industry, and thus, results can be volatile, which is captured in our weak business risk assessment.
We would consider a negative ratings action if debt-to-EBITDA exceeds 4x on a sustained basis as a result of a deterioration in operating performance over the next several quarters. This could occur if a global economic recession were to lead to a drop-off in demand for airplanes and automotives, such that year-over-year revenues and margins declined 100 basis points over 2011 levels, given increased levels of debt. We could also take a negative ratings action if Kaiser were to increase leverage to pursue an acquisition or shareholder-friendly action, such as a special dividend or share repurchase.
A positive rating action is less likely in the near term, given our view of the company's weak business risk profile and its relatively small size and scope. However, one could occur over time, if the company were to increase its size and geographic and end-market diversity to be more in line with a fair business risk assessment.