Assa Abloy has historically generated an EBITDA margin of 18%-20%, independent of swings in the economic cycle, on the back of its strong market position, good pricing power, high degree of aftermarket sales, and good cost control. The large acquisition of Swedish peer Cardo (including Cardo Entrance Solutions AB and Cardo Flow Solutions) at the start of 2011 did not put pressure on Assa Abloy's margins, as we had previously forecast. Cardo Flow Solutions was subsequently sold.
S&P base-case cash flow and capital structure scenario
In our base-case scenario, we forecast that Assa Abloy will generate free operating cash flow (FOCF) of slightly more than Swedish krona (SEK) 4 billion (about EUR430 million) in 2012. This compares with SEK4.1 for the rolling 12 months to Sept. 30, 2011, and SEK4.9 billion in 2010. Our estimate of FOCF reflects our view that the group will continue to achieve stable sales and operating margins with low capital expenditures.
We believe funds from operations (FFO) to debt will reach more than 30% and FOCF to debt more than 20% in 2012, in line with Assa Abloy's historical performance. The group has a publicly stated acquisition target of adding about 5% of revenues to its top line over a business cycle. When incorporating SEK3 billion of annual acquisition spending into our ratings and assumptions, discretionary cash flow is still positive. We do not anticipate further acquisitions of a size similar to Cardo. That said, the disposal gains from Cardo Flow Solutions of more than SEK6 billion substantially mitigated the debt impact of SEK11 billion.
The short-term rating on Assa Abloy is 'A-2', reflecting our view of the company's overall adequate liquidity. As of March 31, 2012, liquidity sources consisted of:
-- Cash and liquid assets of SEK1.2 billion (about EUR133 million), of which we consider about SEK550 million as excess cash;
-- A fully undrawn EUR1.1 billion (SEK9.8 billion) committed syndicated credit facility maturing in 2014, with no financial covenants or material adverse change clause; and
-- Robust FOCF-generating capacity (about SEK4.9 billion in 2010 and 2011), which we anticipate will be much greater than SEK4 billion per year over the medium term in our base-case scenario.
This compares with the following near-term expected cash calls:
-- Debt maturities of about SEK8 billion in the coming 12 months; and
-- Potential acquisition expenditure of SEK3 billion yearly from 2012.
The stable outlook reflects our view that in 2012 and 2013 strong and sustainable FOCF will continue to mitigate the company's relatively high debt, including a fairly high proportion of short-term debt resulting from the group's dividend policy, the large Cardo acquisition and small ongoing acquisitions over the next two years.
We view adjusted funds from operations to debt of about 35% and positive discretionary cash flow generation as commensurate with the current rating. In our base case, we expect the company to generate FOCF of SEK4 billion a year and that overall cash flow generation will be sufficient to compensate for dividend payments and acquisitions.
We would consider lowering the rating if cash flows and credit metrics were to decline significantly below our base-case ratios. We believe this could materialize in the event of major debt-funded acquisitions. A scenario of no revenue growth and deterioration in Assa Abloy's gross margin could also lead to a negative rating action. However, we deem such a scenario unlikely under our current economic forecasts.
An upgrade at this stage is unlikely in our view and would require significant deleveraging.