RPT-Fitch Affirms DSM at 'A-'; Stable Outlook

Wed Jun 25, 2014 4:52am EDT

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June 25 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has affirmed Netherlands-based chemicals group DSM N.V.'s (DSM) Long-term Issuer Default Rating (IDR) at 'A-' and Short-term IDR at 'F2'. The Outlook is Stable. Its senior unsecured debt has also been affirmed at 'A-'

The ratings reflect DSM's position as one of the world's leading specialty chemicals groups, with significant market shares across its broad portfolio of products. DSM's sales are well diversified by geography, product and customer. DSM continues its expansion into high-growth markets, and targets emerging economies to account for 45% of total sales by end-2015 (up from around 40% in 2013).

KEY RATING DRIVERS

Product Mix Underpins Ratings

DSM's geographical and end-market diversification support stable cash-flow generation through the cycle and its recent acquisitions have resulted in an increased exposure to the less cyclical nutrition sector. However, the company remains exposed to economic and industry cycles, and to volatile raw material, FX and energy prices.

2013 in Line with Base Case

Excluding the effect of the deconsolidation of DSM Pharmaceutical Products (DPP), the group's operating performance was roughly in line with Fitch's 2013 base case. Sales from operations increased 5.4% year-on-year (yoy), reflecting primarily the consolidation of the acquisitions in the Nutrition segment. Organic volume growth (5%) was offset by lower prices (-3%) and FX effects (-3%). EBITDA margin improved to 13.4% on the back of the savings realised though the profit improvement programme (PIP).

1Q14 Financial Results

Operating performance in 1Q14 was slightly weaker than the year before with EBITDA down 6%, mainly due to negative FX developments and low vitamin prices. DSM expects an improvement in vitamin E pricing in 2014 which the company later plans to lock into renewed contracts with customers. The company also expects an improvement in Omega 3 sales volumes as customers acclimatise to higher prices. Fitch believes Polymer Intermediates are unlikely to significantly improve in 2014 because of stable caprolactam prices. Declining Asian benzene input prices (already down 8.5% yoy in 1Q14) could support this segment, but Fitch believes overcapacity in caprolactam and still high benzene prices are likely to translate into margins of only 6-7% for Polymer Intermediates in 2014. We project total group 2014 EBITDA margin of around 14%.

PIP to Mitigate Challenges

Our 2014 base case forecasts a further improvement in EBITDA margin in Performance Materials (excluding any negative FX effects), as a mild economic recovery in western Europe and savings from the extended PIP offset pricing pressure in composite resins (building and construction sector). PIP and other cost saving programmes target additional structural annual EBITDA gains of EUR140m-EUR170m by end-2015 on top of the EUR160m realised in 2013, with associated costs of EUR90m-EUR100m to be incurred in FY14.

Pharma Changes Neutral

The Pharma division ceased to exist in 2014 and DSM now applies the equity method (IFRS11) for its two joint ventures (JVs). These are 50%-owned DSM Sinochem Pharmaceuticals and the 49%-owned JV DPx Holdings B.V. that combines DSM Pharmaceutical Products with US company Patheon (completed in March 2014). They contributed EUR54m to EBITDA (7% margin) in 2013 and DSM's 2014 margins should benefit from their deconsolidation. The scope of the new JV should enhance its competitiveness in the challenging contract manufacturing market.

Sound Liquidity

Liquidity is supported by cash positions of EUR480m at end-1Q14 and available committed revolving credit facilities of EUR1bn maturing in 2018. In February 2014 DSM issued a EUR500m 2.375% bond due 2024 to refinance a note of the same amount maturing in March. Total borrowings maturing in less than one year was EUR391m at end-1Q14. Under our base case, free cash flow remains positive over 2014-15.

Working capital deteriorated in 1Q14, due to higher inventories and receivables. The company has a target for working capital to be 21% of annualised sales. As of end-1Q14 this was 23.6%, but management notes that 1Q working capital is typically higher than 4Q. Sustained weakness in working capital beyond normal seasonal variations would represent a threat to the ratings.

RATING SENSITIVITIES

Factors that could lead to a negative rating action:

-Although currently regarded as unlikely, large debt-financed acquisitions or shareholder-friendly actions (dividends, share buybacks) resulting in a sustained increase in net funds from operations (FFO) leverage above 2.0x (end-2013: 2.1x) could warrant a negative rating action

-EBITDA margin consistently below 10%

-Difficulty in implementing the company's "driving focused growth" strategy into 2015, given the risks associated with the company's plan of expanding into high-growth economies to achieve annual organic sales growth of 5% to 7% Factors that could lead to a positive rating action:

-Further diversification away from cyclical sub-sectors, along with FFO net adjusted leverage sustained at 1.0x

-Improving operations performance with EBITDA margins consistently around 20%

-Lower volatility in the Performance Materials segment resulting in consistent revenues and improved profit margins

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