TEXDT-S&P affirms Graphic Packaging International ratings
Overview -- U.S.-based Graphic Packaging announced two acquisitions to be funded from revolver borrowings and plans to enter into an incremental term loan facility to fund a share repurchase. -- We are affirming our ratings on Graphic Packaging, including the 'BB+' corporate credit rating. -- We are assigning our 'BBB' issue-level rating to the company's proposed $300 million senior secured term loan. -- The stable outlook reflects our expectation that the company will continue to generate relatively steady earnings and sizeable free cash flow resulting in modest debt reduction in 2013. Rating Action On Dec. 11, 2012, Standard & Poor's Ratings Services affirmed its ratings, including the 'BB+' corporate rating, on Atlanta, Ga.-based Graphic Packaging International Inc. (Graphic Packaging). The rating outlook is stable. We also assigned our 'BBB' issue-level ratings to the company's proposed $300 million senior secured incremental term loan. The recovery rating is '1', reflecting our expectation that lenders can expect to achieve very high (90% to 100%) recovery in the event of a payment default. Proceeds from the proposed term loan are to be used to repurchase and cancel stock of Graphic Packaging Holding Co. Rationale The ratings affirmation reflects our expectation that Graphic Packaging will be able to maintain its "significant" financial risk profile despite a modest increase in debt following the announced acquisitions and proposed share repurchase. Specifically, we forecast annual free cash flow in excess of $200 million in 2013 and 2014 and leverage declining to 3x over this period from about 4x pro forma following the proposed transactions. In addition, we view the acquisitions, share repurchase, and incremental debt as not deviating substantially from management's stated financial policy, which we view as consistent with a significant financial risk profile. The ratings on Graphic Packaging reflect the combination of what we consider to be its "satisfactory" business risk and significant financial risk profiles. We expect further leverage reduction from free cash flow to result in leverage in the mid-3x area and funds from operations (FFO) of about 20% at the end of 2013. We view these credit metrics as consistent with the rating and our assessment of the company's significant financial risk profile. Our satisfactory business risk profile reflects our view of the company's long-term customer relationships, position as the largest North American producer of folding cartons with 32% market share, and its value-added product mix. The ratings also incorporate our expectations for no additional large debt-financed acquisitions, share repurchases, or dividends to its concentrated shareholder base. Under our baseline scenario, we believe Graphic Packaging's 2012 EBITDA could increase to $670 million or more from the $620 million it generated in 2011. For 2013, we estimate EBITDA could approach $700 million based on incremental acquisition-related EBITDA and benefits from ongoing productivity improvements and cost reductions of $60 million to $80 million per year. Other key assumptions to our EBITDA forecast include: -- Limited demand improvement for paperboard packaging products, based on a gradual economic recovery, with annual U.S. real GDP growth of 2.3% in 2013. -- Modestly lower contractual selling prices reflecting 2012's raw material deflation. -- Modest cost inflation (for wood, petroleum-based materials, and energy) in 2013. A key risk to our forecast is a weaker U.S. economic recovery, which we expect to hurt demand, albeit to a lesser extent than for other forest products companies, given Graphic Packaging's relatively stable food and beverage end markets. Other risks include lower profitability that may temporarily arise from greater-than-expected raw material input cost inflation that is not offset by price increases. We view this risk to be largely mitigated by the company's customer supply agreements that contain inflation recovery provisions. As of Sept. 30, 2012, pro forma total debt (including $300 million of proposed incremental term loans, $150 million of acquisition-related revolver borrowings, and adjustments for pension liabilities and operating leases) was $2.8 billion, compared with $2.7 billion at the end of 2011. Based on our EBITDA assumptions, we expect the company to generate $200 million or more of annual free cash flow in 2013 and 2014, which we believe it could use to further reduce debt. As a result, we believe leverage could drop to the mid-3x area by the end of 2013, compared with just over 4x (including the incremental term loan and revolver borrowings) for the trailing 12-months ended Sept. 30, 2012. In addition, we believe FFO to debt is likely to be about 20% by the end of 2013 and further improve thereafter. Graphic Packaging manufactures paperboard, most of which it uses internally to produce beverage carriers or folding cartons for food, household goods, and other consumer products that tend to be recession-resistant. As a result, the paperboard segment (84% of sales) fared relatively well during the most recent U.S. recession, with revenue declining by less than 5%. Its relatively lower-margin multi-wall bag and specialty plastics packaging business (16% of sales) was combined with the assets of two other entities to vertically integrate the business, realize meaningful synergies, and improve overall profitability. Our view of Graphic Packaging's management and governance is "fair". Liquidity Our assessment of Graphic Packaging's "strong" liquidity profile is based on the following expectations: -- Sources of liquidity (including forecasted FFO, cash balances, and availability on its revolver) will exceed uses by 1.5x or more over the next year. -- Liquidity sources will continue to exceed uses, even if forecasted EBITDA declines by 30%. -- Sufficient covenant headroom exists for forecasted EBITDA to decline by 30% without the company breaching coverage tests. Financial covenants governing its credit agreement include a maximum leverage ratio of 4.75x and minimum interest coverage of 3x. -- The leverage covenant steps down to 4.5x beginning March 31, 2013, and to 4.25x beginning March 31, 2014. As of Sept. 30, 2012, and prior to the acquisitions, cash balances were $36.5 million and $675.4 million was available under the company's $1.0 billion revolving credit facility due March 2017 and international revolving credit facilities. Based on our current operating assumptions and annual capital expenditures of $190 million to $210 million, we expect annual free cash flow to be $200 million or more in each of the next two years. The company doesn't currently pay a dividend, and our ratings incorporate our expectation that any additional acquisition activity or potential dividends or share repurchases would be financed in a manner consistent with our assessment of the company's significant financial risk profile. Graphic Packaging does not have any significant debt maturities until 2017. Term loan amortization under its credit agreement is 5% in the first two years, 7.5% in year three, and 10% thereafter. Recovery analysis We rate Graphic Packaging's senior secured debt 'BBB' (two notches above the corporate credit rating) with a '1' recovery rating. The '1' recovery rating reflects our view that lenders would experience very high (90% to 100%) recovery in the event of a payment default. We rate the company's senior notes 'BB+' (the same as the corporate credit rating) with a '3' recovery rating. The '3' recovery rating reflects our view that lenders would experience meaningful (50% to 70%) recovery in the event of a payment default. For the recovery analysis, see the report on Graphic Packaging to be published shortly after this report on RatingsDirect. Outlook The rating outlook is stable. We expect Graphic Packaging to continue to generate relatively steady earnings and sizeable free cash flow and remain committed to modest debt reduction, so that credit measures remain in line with the ratings. Based on our EBITDA projections, we expect free cash flow generation to be $200 million or more in each of the next two years, leverage to approximate 3.5x, and FFO to debt to be about 20% by the end of 2013. We view these credit measures as consistent with the 'BB+' corporate credit rating, given the company's satisfactory business risk profile. For a higher rating, our assessment of Graphic Packaging's financial risk would need to improve to "intermediate" from "significant," based on its satisfactory business risk profile. This could occur if leverage was sustained at or below 3x and FFO to debt above 30% and we viewed the company's financial policy as consistent with a low-investment-grade rating. For this to occur, earnings would have to improve more than 15% from our 2013 EBITDA forecast and stay at that level, which we view as unlikely given our cautious economic outlook. In addition, for a higher rating we would have to anticipate that the company would finance any potential dividends, share repurchases or acquisitions such that credit metrics remained consistent with an intermediate profile. We could lower the rating if free cash flow were to significantly decline or be used for other activities, such as excessive shareholder rewards, large acquisitions, or initiatives, causing leverage to remain above 4x, with FFO to debt in the mid-teen percentage area. This could occur with minimal debt reduction and if EBITDA were to decline 15% from our 2013 forecast and stay at that level. Related Criteria And Research -- Top 10 Investor Questions For 2013: Global Forest Products, Dec. 5, 2012 -- Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011. -- Key Credit Factors: Criteria For Rating The Forest Products Industry, Dec. 11, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed Graphic Packaging International Inc. Corporate Credit Rating BB+/Stable/-- Senior Secured BBB Recovery Rating 1 Senior Unsecured BB+ Recovery Rating 3 New Ratings Graphic Packaging International Inc. Senior Secured US$300 mil term incremental A-2 bank ln due 2017 BBB 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.