(The following statement was released by the rating agency)
Dec 12 -
Summary analysis -- Sika AG --------------------------------------- 12-Dec-2012
CREDIT RATING: A-/Stable/A-2 Country: Switzerland
Primary SIC: Adhesives and
Credit Rating History:
Local currency Foreign currency
02-May-2000 A-/A-2 A-/A-2
The ratings on Switzerland-based technical chemical producer Sika AG reflect our of its "strong" business risk and "modest" financial risk profiles. Our business risk assessment reflects the group's favorable profitability (as measured by EBITDA minus maintenance capital expenditure and return on capital), strong and strengthening market positions worldwide as a manufacturer of technical chemicals for the construction sector, solid long-term growth prospects, and established positions in adhesives and sealants for the auto and transportation industries. Rating constraints include Sika's sensitivity to the cyclical construction end market, raw material expenses that equate to a sizable percentage of sales, competition, and capital intensity to expand business.
In 2011, revenue reached Swiss franc (CHF) 4.6 billion (EUR3.8 billion), split between two divisions: Construction (81% of sales) and Industry (19%). Europe remained the main revenue-earning region (47%), followed by Asia-Pacific (17%), and North America (14%).
Sika's strong market positions are supported by its value-added business model, articulated around high-quality products, innovation, and customized solutions to focus on the most demanding applications. This is a key differentiating factor from lower-end competitors. We think Sika's high-quality brand exemplifies this stance and further supports its market positions. The industry's increased utilization rates and substitution that favors Sika's engineered products should continue to result in favorable demand prospects and strong growth in emerging countries, where penetration rates remain lower than those in Western Europe.
That said, with construction continuing to make up most of its revenue, Sika is exposed to swings in demand, although, we believe, less so than other groups that depend on this end market. Demand for Sika's products in mature markets is to a large extent for renovation and repair, which are more stable areas. We understand that 40% of the Construction division's sales are tied to infrastructure, 40% to commercial activities, and only 20% to residential construction, which we view as the most cyclical.
Sika's Industry division--which manufactures industrial adhesives and sealants--provides some diversity. It is mostly exposed to the cyclical transportation industries: bus, truck, rail, and automotive OEM. It also sells to the more stable aftermarket.
Sika also faces volatile raw material prices, which represent a substantial share of revenue (49.6% in 2011), and may only be passed on to clients with a three- to nine-month delay. About 70% of raw materials are oil-derived.
Sika's modest financial risk profile captures a long track record of, and our expectations of continuing, supportive financial policies, strong credit metrics, largely positive free operating cash flow (FOCF), and solid liquidity. We view the company's majority family-ownership as supportive of Sika's prudent financial policies.
S&P base-case operating scenario
Our base-case scenario points to EBITDA of more than CHF550 million in 2012 and 2013, compared with about CHF475 million in 2011, as acquisitions and price increases improve earnings. EBITDA in the first nine months of 2012 neared CHF450 million.
The macroeconomic outlook for the fourth quarter of 2012 and 2013 is highly uncertain, especially in Europe and North America where Sika will continue to derive most of its revenue. However, as demonstrated in the 2009 financial downturn, we believe Sika could display good resilience and much better performance than other companies serving the construction end market. Sika derives an increased amount of revenue from emerging markets; focuses on infrastructure projects as opposed to residential activity; emphasizes high-end, higher-growth applications; and should continue to make several small acquisitions that boost its market positions and cross-sales opportunities. We also note positively that South Europe contributes modestly to Sika's revenue ("Europe South" in Sika's reporting includes more northerly countries, namely France, the U.K., and Ireland).
We consider one of the main pressuring factors in emerging and mature economies to be lower infrastructure spending as public authorities and companies cut or postpone projects. Growth in Sika's Asia-Pacific markets slowed considerably in the first nine months of 2012 to 3.4% (in local currencies), mainly because infrastructure projects in China were put on hold for review.
S&P base-case cash flow and capital-structure scenario
We expect Sika's credit metrics to remain strong for the rating in 2012, with the ratio of funds from operations (FFO) to debt above 50% and very positive FOCF. This compares with FFO to debt at 50% on June 30, 2012 and Dec. 31, 2011, and the 45% ratio that we consider rating-commensurate. On June 30, 2012 and Dec. 31, 2011, debt to EBITDA was a low 1.6x, indicative of Sika's conservative financial policy. Sika's Standard & Poor's-adjusted debt was moderate at CHF820 million on June 30, 2012.
As a result, Sika has leeway to continue with its acquisitions, which we believe will remain focused on several small to midsize companies instead of large ones. We assume in our base-case scenario annual cash outlays of CHF150 million, compared with CHF144 million in 2011.
One of the goals of the acquisitions is to access markets, rather than gain technologies, given the very local nature of the business. Even for large infrastructure projects, materials can be sourced locally from different suppliers. Acquisitions also enhance the company's share of emerging economies, access to clients, and product reach. We believe they are necessary for Sika to achieve its long-term CHF8 billion revenue target, since organic growth is unlikely to suffice.
The short-term rating is 'A-2'. We classify the group's liquidity as "strong," since we expect sources to surpass needs by above 1.5x in 2012 and 2013, among other factors.
Sika successfully issued in June 2012 two long-term bonds at very low rates, which demonstrates in our view the company's strong liquidity and standing in the capital markets. The six-year bond has a coupon of only 1%, while the 10-year bond bears 1.75%.
Our base-case credit scenario takes into account the following supportive factors in the year from July 1, 2012:
-- Cash and cash equivalents of CHF390 million at the beginning of the period, of which we consider CHF50 million to be tied to operations and thus not netted from adjusted debt. Cash is the core liquidity source. We note positively that almost all cash is held in Swiss banks in Switzerland and in Swiss francs. We foresee no change to this policy;
-- Proceeds of CHF300 million from two long-term bonds issued in June 2012 and cashed in in July;
-- No financial covenants; and
-- Robust FOCF of about CHF200 million in 2012 and 2013. We factor in capex nearing CHF150 million, of which CHF50 million is for maintenance, which compares with less than CHF120 million in 2011.
We factor in the following needs:
-- A CHF250 million bond, maturing in February 2013, and refinanced with the bonds issued in June 2012. The next maturity (a CHF300 million bond) is due in 2014;
-- Small-scale bolt-on acquisitions, totaling CHF150 million annually; and
-- Dividends of about CHF120 million in 2012 and 2013, 5% higher than in 2011.
Given the group's high cash balances and its expectations for cash flow generation, Sika has not renewed a CHF450 million committed revolving credit facility, which matured in November 2010.
The stable outlook reflects our view that Sika will deliver positive FOCF in the coming years, owing to robust EBITDA generation and commensurate capex, while maintaining its conservative financial policy, and its balanced approach to investments, acquisitions, and dividends. We consider FFO to debt of about 45% and FOCF to debt of 20%-25% through the cycle, which we believe Sika will likely achieve or surpass, to be commensurate with the rating.
We could consider lowering the ratings if the group deviates from its financial policy, for instance, by making large debt-financed acquisitions. We might also downgrade if profits are less resilient to a downturn in 2012 than we currently estimate.
We currently see no rating upside given Sika's exposure to cyclical segments, its modest diversity by end market, and its size in comparison with its 'A'-rated peers.
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