TEXT - S&P cuts Schmolz + Bickenbach AG to 'B-'
(The following statement was released by the rating agency) Overview -- Specialty steel producer Schmolz + Bickenbach AG will likely post much weaker EBITDA in 2012 than we anticipated, and we think the group will continue to face tough conditions in 2013. -- Consequently, Schmolz + Bickenbach's debt to EBITDA ratio will likely increase beyond our expectation in 2012 and remain high next year. -- We are lowering our long-term rating on Schmolz + Bickenbach to 'B-' from 'B' and removing the rating from CreditWatch negative. -- The negative outlook reflects the possibility that we could consider lowering the rating if financial covenants for 2013 are not reset in a timely manner or we see significantly negative free operating cash flow next year. Rating Action On Dec. 17, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit rating to 'B-' from 'B' on Switzerland-headquartered specialty long steel producer Schmolz + Bickenbach AG. We also removed the rating from CreditWatch with negative implication, where we had placed it on Nov. 12, 2012. The outlook is negative. At the same time we lowered the issue rating on the company's senior secured EUR258 million bond due in 2019 to 'B-'. The recovery rating on the bond is unchanged at '4', indicating our expectation of average (30%-50%, at the low end of the range) recovery in the event of a payment default. Rationale The downgrade reflects our expectation of higher leverage (debt to EBITDA) in 2012 and 2013 than we previously anticipated. We now foresee that Schmolz + Bickenbach will post a Standard & Poor's adjusted debt to EBITDA ratio in excess of 8.0x in 2012, before improving to 7.0x in 2013 under our base case. We have also factored in our expectation that 2013 EBITDA will stay low, consequently extending the company's risk of covenant breach into next year. We base our revised forecast on the likelihood, in our view, of a protracted recession in the automotive industry in Europe in 2013, which accounts for about a third of Schmolz + Bickenbach's revenue. In particular, we don't foresee a significant upturn in Germany, which accounts for nearly 50% of group revenue on average. Under our revised base case, EBITDA in 2012 will likely come at about EUR140 million (after restructuring costs), versus EUR300 million in 2011. This factors in fourth-quarter EBITDA close to breakeven level. The roughly 50% drop in EBITDA follows an anticipated close to 10% volume decline, illustrating the company's high operating leverage. For the following year, we anticipate roughly stable sales volumes, but possibly EBITDA up slightly to $150 million-$160 million thanks to the restructuring programs. Still, Schmolz + Bickenbach's EBITDA remains hard to predict given its high operating leverage. In the absence of marked EBITDA improvement next year, the risk of covenant breach will extend into 2013, in our view. After obtaining covenant waiver approvals from the core banks for the rest of 2012, the company's management will likely take proactive actions to ensure covenant compliance next year. However, what approach the banks will take is difficult to foresee in the context of lingering industrial weakness in Europe and their own reduced risk appetite. We view the group's business risk profile as "weak" and its financial risk profile as "highly leveraged" under our criteria. Exposure to the export-oriented German economy, as well as diversification in three segments of specialty steel--tool, engineering, and long stainless steel--are competitive advantages for Schmolz + Bickenbach compared with some peers such as Captain Bidco SAS (B-/Negative/--), which focuses on engineering steel and is predominantly exposed to France. The financial risk profile is constrained by our anticipation of high debt to EBITDA in excess of 8.0x in 2012. Still, we think the new management team that will be in place as of February 2013 and the board will stay focused on deleveraging. Liquidity We continue to assess Schmolz + Bickenbach's liquidity as "less than adequate," according to our criteria. The key risk remains the covenant breach risk in 2013 under the company's core EUR600 million syndicated facility. Covenant headroom aside, and as long as the covenants are waived and the syndicated facility remains available, we estimate that the ratio of sources to uses will be comfortably above 1.2x for the next two years. Key sources of liquidity for the 12 months to Oct. 1, 2013, include: -- FFO of about EUR70 million-EUR80 million. -- About EUR380 million of availability under its committed long-term credit lines, of which EUR310 million under the syndicated loan maturing in May 2015 and another EUR70 million under the EUR300 million asset-backed securities (ABS) facility maturing in April 2015. -- Potential for working capital inflows. Potential uses of liquidity over the same period include about $100 million of capital expenditure (capex) and moderate debt maturities of less than EUR30 million. The company doesn't have substantial debt maturing before 2015. Although Schmolz + Bickenbach reports drawings under the company's ABS facility as short-term debt (EUR231 million at end-September 2012), we consider such advances as long-term funding, given that the asset-backed commercial paper (ABCP) program will mature in April 2015 and is backed by a committed bank line with the same amount and maturity as the program itself. Recovery analysis The issue rating on Schmolz + Bickenbach's EUR258 million senior secured high yield notes due in 2019 is 'B-', in line with the corporate credit rating. The recovery rating on these notes is '4', indicating our expectation of average (30%-50%, at the low end of the range) recovery in the event of a payment default. The notes are issued by a 100% owned special-purpose vehicle, Schmolz + Bickenbach LUXCO S.A. (not rated), and were used to refinance existing debt. The recovery rating of '4' is underpinned by the company's fair valuation; the notes' strong guarantee package provided by entities accounting for over 80% of the group's assets, sales, and EBITDA; and the creditor-friendly Swiss and German jurisdictions in insolvencies, in our opinion. The rating is constrained by the notes' junior position to the EUR300 million ABCP program, EUR100 million in KfW IPEX-Bank GmbH loans, and various bilateral lines held at nonguarantor subsidiaries. The recovery rating is also constrained by the notes' weak security package, comprised mostly of intangible assets. To calculate recoveries, we simulate a default scenario. Under our hypothetical payment default scenario, we value Schmolz + Bickenbach on a going-concern basis. Given the cyclicality of the company's business and its high operating leverage, we believe that a default would most likely occur in 2014. This is because of falling revenues resulting from a deteriorated operating environment, which, combined with the company's significant debt, would lead to a payment default. At our hypothetical point of default, EBITDA would have declined to about EUR155 million, and we estimate a stressed enterprise value of approximately EUR780 million. After deducting enforcement costs and priority claims, comprising mainly pension deficit claims and operating leases, residual available value would amount to about EUR628 million. At our simulated point of default, claims under the priority ranking debt would likely amount to about EUR346 million, including six-months prepetition interest. This would leave about EUR282 million residual value available for noteholders and equally ranking debt, composed of a EUR600 million syndicated facility and a $48 million Kfw Ipex U.S. loan, which results in recovery prospects at the low end of the 30%-50% range, corresponding to a recovery rating of '4'. Outlook The negative outlook reflects the risk of covenant breach in 2013. We could lower the rating if Schmolz + Bickenbach didn't reset its covenants for 2013 in a timely manner and if we perceived waning bank support. Weaker demand than we currently expect in 2013 and pronounced negative FOCF could also lead to a downgrade. We could revise the outlook to stable if the risk of covenant breach in 2013 were waived successfully and in a timely manner. For the rating on Schmolz + Bickenbach to stabilize, we would also expect to see a stable operating environment. We don't foresee rating upside for the next 12 months. Such upside would chiefly depend on the company's deleveraging efforts. Healthier demand in Europe and stronger cash flow generation could support the company's debt reduction, in our view. Related Criteria And Research -- Criteria 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: Methodology And Assumptions On Risks In The Metals Industry, June 22, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; CreditWatch Action To From Schmolz + Bickenbach AG Corporate Credit Rating B-/Negative/-- B/Watch Neg/-- Schmolz + Bickenbach LUXCO S.A. Senior Secured* B- B/Watch Neg Recovery Rating 4 4 *Guaranteed by Schmolz + Bickenbach AG (Caryn Trokie, New York Ratings Unit)