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TEXT-Fitch affirms PPG Industries' IDR at 'A-'; outlook stable
During the past year, management has taken steps to further its strategy of transforming PPG into primarily a coatings and specialty products company. In July 2012, the company announced its plan to separate its commodity chemicals business and merge it with Georgia Gulf Corporation (NYSE: GGC) in a tax-efficient transaction. The separation is expected to occur during the first quarter of 2013. More recently, PPG signed a definitive agreement to acquire the North American architectural coatings business of AkzoNobel N.V. (AkzoNobel) for $1.05 billion. This transaction is expected to close during the second quarter of 2013. On a pro forma basis, coatings sales will represent roughly 85% of total revenues, up from 57% in 2006.
PPG expects to pay $875 million of cash for the acquisition, which will be funded by existing cash on hand. In addition, the company also announced that it will reinitiate its share repurchase program immediately following the completion of the separation of its commodity chemicals business. The company expects to repurchase $500 million - $750 million of stock during 2013. PPG also has $600 million of senior notes that mature in March 2013.
Fitch believes that the company will fund the expected $2 billion to $2.5 billion of cash outflows with cash on hand. At Sept. 30, 2012, PPG had $1.39 billion of cash and $619 million of short-term investments. The company's cash position will be further increased next year with the expected receipt of $900 million of cash from the separation of its commodity chemicals business, which is expected to close during the first quarter of 2013.
Fitch expects PPG will continue to have solid liquidity following the cash outflows projected for 2013. Fitch projects PPG will generate free cash flow (FCF) of between $500 million and $550 million during 2013 and end the year with cash in excess of $1 billion. In addition, Fitch expects the company will have full availability under its $1.2 billion revolving credit facility that matures in September 2017.
While the planned divestiture and acquisition is consistent with management's strategy, these transactions will initially result in the loss of somewhat meaningful EBITDA (roughly $400 million from the commodity chemicals business) and cash flow for the company. Additionally, the commodity chemicals business provided some hedge against rising raw materials costs. During periods of escalating coatings input costs, selling prices for PPG's commodity chemicals products have also tended to be higher.
The company's credit metrics are also expected to weaken in the near term due the EBITDA and cash flows that will be lost from the divestiture. On a pro forma basis excluding the results from the chemicals business, leverage as measured by debt to EBITDA is expected to rise above 2.0x for fiscal 2012 from 1.7x at the end of 2011. Fitch expects leverage will be below 2.0x by year-end 2013 as the company pays down debt and increases EBITDA from restructuring initiatives begun over the past few quarters. The acquisition of AkzoNobel's business is not expected to contribute significantly to EBITDA during 2013. These ratios remain appropriate for the current ratings.
Fitch's rating takes into account the cyclicality of many of PPG's end-markets. Construction and automotive original equipment manufacturers (OEM) typically account for between 35%-45% of its end-markets' sales. Fitch currently expects global auto demand will rise in the low-to mid-single-digit range in 2013, with moderate growth in North America and China and relatively modest improvement in most other emerging markets. However, European demand is expected to fall further. Fitch also forecasts moderate improvement in overall U.S. construction spending this year. Fitch projects total U.S. housing starts to increase 16.7% in 2013, while home improvement spending is projected to grow 4% next year. Private non-residential construction spending in the U.S. is projected to advance about 5% in 2013.
The company has been a defendant in lawsuits involving asbestos claims for over 30 years, mostly related to its 50% ownership of Pittsburgh Corning Corporation (PC), a 50 - 50 venture owned by PPG and Corning Incorporated. Under the terms of the current settlement arrangement, PPG would make aggregate cash payments of approximately $825 million (payable according to a fixed payment schedule over a period ending in 2023), contribute 1.4 million shares of its stock, and convey the stock it owns in PC to a trust. PPG's participating historical insurance carriers would make cash payments to the trust of approximately $1.7 billion. The company has taken charges totaling $812 million for the estimated cost of the settlement arrangement, including an initial charge of $772 million during the second quarter of 2002. If the asbestos settlement becomes effective, Fitch believes that the company has sufficient cash and CP/bank revolver availability to meet the required cash payments.
In addition, the company also has $162 million of reserves for asbestos-related claims that will not be channeled to the trust. PPG currently does not have sufficient current claim information or settlement history on which to base a better estimate of this liability. The current settlement agreement also does not cover 'premises' claims, which comprise less than 2% of the total asbestos related claims against PPG.
Future ratings and Outlooks will be influenced by broad end-market trends, as well as company specific activity, particularly FCF trends and uses.
While Fitch does not currently anticipate a positive rating action in the next 12-18 months, a positive rating action may be considered if the company's leverage is consistently in the 1x - 1.5x level and PPG maintains a high cash balance until its asbestos liabilities are settled.
Negative rating actions could occur if PPG performs in line with Fitch's 2013 stress case forecast, including revenue declines of 10%, EBITDA margins falling to between 11% - 12% and leverage levels consistently above 2.5x. Additionally, Fitch may consider a negative rating action if management undertakes a meaningful share repurchase program funded by debt, resulting in consistent debt-to-EBITDA levels above 2.5x.
Fitch has affirmed the following ratings with a Stable Outlook as follows:
--Long-term IDR at 'A-';
--Senior unsecured debt at 'A-';
--Unsecured revolving credit facility at 'A-';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
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