We anticipate that K+S' earnings will remain subject to potential large swings because we consider potash prices and volumes will remain the largest profit driver. These depend on various fluctuating factors, such as farmers' incomes and buying behavior, harvests, weather conditions, crop prices, competition, and the industry supply/demand balance. Worldwide demand for potash declined at a record pace in 2009, well beyond our low-cycle assumptions. Following the acquisition of Morton Salt in 2009, the proportion of EBITDA from the salt division increased significantly to 33% by 2011, which should help smooth some of the volatility in the fertilizer segment. Still, the salt industry is highly seasonal and profits can significantly change from one year or season to another.
We classify K+S' financial profile as "modest.." Our assessment takes into account the likelihood that the company's credit metrics may fluctuate in pace with cyclical EBITDA, as well as some capital intensity for maintenance, material capital intensity for expansion (especially green-field potash projects), and K+S' target shareholder distributions. The "modest" financial risk profile also assumes that K+S can achieve funds from operations (FFO) to debt of at least 45% and debt to EBITDA below 1.5x under our assumed mid-cycle EBITDA of EUR900 million. We believe the company could achieve much better metrics in top-of-the-cycle industry conditions.
S&P base-case operating scenario
Our profit outlook for K+S is favorable for 2012 and 2013, reflecting our view of supportive industry conditions (supply/demand balance) in the fertilizer industry leading to high prices. We also expect stable to slightly increasing volumes, based on favorable end market demand and high crop prices.
As a result, we expect K+S to report revenues around EUR4 billion and EBITDA of about EUR1.1 billion in 2012 (both flat versus 2011). While this translates into a much higher margin than in 2011 (at around 28% against about 22%), this reflects the sale (completed last July) of the lower-margin K+S Nitrogen trading business. On a comparable basis, we assume the margin to be broadly unchanged.
S&P base-case cash flow and capital-structure scenario
We anticipate that K+S will retain very strong credit metrics for the rating in 2012 and 2013, especially thanks to supportive industry conditions.
In our base-case scenario, we anticipate that K+S will generate adjusted FFO of about EUR0.9 billion in 2012, which comfortably covers the capital spending of EUR0.7 billion we assume. This compares with adjusted FFO of EUR0.7 billion and adjusted capital spending of EUR0.3 billion in 2011.
We forecast that K+S' adjusted FFO to adjusted debt will remain at more than 75% in 2012 (compared with 122% in 2011), which comfortably exceeds what we consider commensurate with the current ratings, but also reflects very favorable industry conditions.
The short-term rating is 'A-2'. We classify the company's liquidity as "strong" under our criteria because we expect liquidity sources to exceed needs by more than 1.5x over the next 12-24 months, among other factors.
In our base-case scenario, K+S has the following liquidity sources:
-- Reported cash and equivalents of EUR1 billion on eJune 30, 2012, of which we view EUR70 million as tied to operations;
-- An unused EUR800 million committed credit line. This facility matures in July 2015, which we view as positive. It is subject to financial covenants (net debt to EBITDA) under which the company had meaningful headroom on Dec. 31, 2011, a situation we expect will continue in 2012; and
-- FFO of about EUR0.9 billion in 2012.
In our base-case scenario, K+S has the following liquidity needs:
-- Virtually nil short-term debt on eJune 30, 2012;
-- Capital spending of about EUR0.7 billion in 2012, increasing to about EUR1 billion in 2013. We factor in EUR400 million for K+S' core operations (excluding recently acquired Canadian subsidiary Potash One). Such core capital spending includes the Werra water protection project, with large total outlays of EUR360 million between 2011 and 2015. The project aims to improve the quality of water of the Werra and Weser rivers in Germany. We also factor in material capital spending tied to the development of a green-field potash mine in Canada of Canadian dollar (CAD)2.9 billion (EUR2.2 billion) between 2011 and 2016, following the Potash One acquisition;
-- Dividends that we assume will remain in line with the company's publicly announced distribution of 40%-50% of adjusted group earnings. We estimate a distribution to shareholders of about EUR250 million in 2012; and
-- Moderate working capital outflows in the vicinity of EUR75 million per year.
The stable outlook reflects our view that continuously strong demand for potash fertilizers, with no major industry capacity addition, should continue to result in high fertilizer prices and enable K+S to maintain strong EBITDA around EUR1.1 billion in 2012 and 2013. We expect the company's FFO to debt to stay sustainably above 60% in 2012 and 2013, while we view 45% as rating-commensurate under mid-cycle industry conditions. Free operating cash flow should remain positive in 2012, while it could be slightly negative in 2013 due to higher capital spending.
We could lower the ratings if FFO to debt decreases to below 45% on a lasting basis following a steep fall in potash prices, a large-scale debt-financed acquisition, or substantial shareholder returns that are currently not included in our base case.
The possibility of an upgrade in the near term is constrained by our view of the company's only satisfactory business risk profile.
Related Criteria And Research
-- 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: Business and Financial Risks In The Commodity And Specialty Chemical Industry, Nov. 20, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008