-- Operating results for Ohio-based chemicals producer Ferro Corp.
have deteriorated in recent quarters, and the company has significantly
lowered its earnings guidance for 2012.
-- We lowered our corporate credit rating on Ferro to 'B+' from 'BB-' and
lowered all our issue-level ratings by one notch.
-- The stable outlook reflects our expectation that, despite a
significant reduction in 2012 EBITDA, the company will be able to maintain
adequate liquidity and a financial profile consistent with the ratings.
On July 30, 2012, Standard & Poor's Ratings Services lowered its corporate
credit rating on Ferro Corp. to 'B+' from 'BB-'. We also lowered the
issue-level ratings on the company's senior unsecured debt to 'B-' from 'B'.
The '6' recovery rating, which remains unchanged, reflects our expectation for
negligible (0% to 10%) recovery in the event of a payment default. The outlook
The downgrade follows the company's announcement that it has significantly
lowered its earnings guidance for 2012. The reduction in earnings expectations
reflect the continued weakness in Europe (which represents roughly one-third
of the company's revenues), subdued demand in the electronic materials
segment, particularly for the company's conductive pastes used in solar
panels, and increased pension expense. We modified our initial expectation
that earnings would moderately grow in the second half of the year, to now
being in line with first-half levels. Given the continued economic uncertainty
and reduced earnings expectations, we now believe that the key ratio of funds
from operations (FFO) to total adjusted debt will fail to meet our previous
expectations of 20%, a level we had considered appropriate for the 'BB-'
rating. Based on our scenario forecasts for moderately lower cash flows in
2012, we expect this ratio will decline to about 15%, which we consider in
line with an "aggressive" financial risk profile and appropriate for the
current rating. Accordingly, we revised our assessment of the financial risk
profile to "aggressive" from "significant".
The ratings on Ohio-based Ferro Corp. reflect our assessment of the company's
business risk profile as "weak" and financial risk profile as "aggressive."
With annual sales of $1.9 billion, the company produces a variety of
performance materials and chemicals for use, primarily in the electronics,
construction, appliances, automotive, and household furnishings end markets.
Ferro operates in six business segments: electronic materials, color and glass
performance materials (which include high-quality glazes, enamels, pigments,
and dinnerware decoration colors), performance coatings (which include tile
coatings and porcelain enamel for appliances and cookware), polymer additives,
specialty plastics, and pharmaceuticals.
Ferro remains vulnerable to cost fluctuations for its raw materials and has
significant exposure to residential and commercial construction and
electronics end markets. Many of the company's products are discretionary
purchases, which renders their demand highly sensitive to extended cyclical
downturns. In addition, profitability in some business segments (such as
polymer additives, which make up about 15% of sales) is suffering because of
commodity-like and highly competitive markets. Partially offsetting these
weaknesses are the company's leading market positions in some of its segments,
a diverse portfolio of performance materials and chemicals, geographic and
customer diversification, and an improved cost structure. Its top 10 customers
account for about 20% of sales, and it generates more than 50% of revenues
outside of the U.S. (although a significant portion of that is derived from
the weak European market).
Over the last year, the company has been affected by a reduced amount of paste
now being used in solar cells (thrifting). In addition, the solar industry has
also felt the effects of reductions in government subsidies for solar use in
parts of Europe, and increased solar panel competition, which led to
production overcapacities, excess inventories of solar panels and rapid price
declines. Additionally, recent tariffs imposed on Chinese solar manufacturers
add further uncertainty to near-term demand. Given the expectation that this
segment will remain weak over at least the near term, the company's efforts to
secure additional product qualifications and increase share with Asian Tier 1
customers will remain key to improving earnings in the electronic materials
segment. At its peak, solar represented a sizeable portion of the company's
EBITDA and had significantly higher margins than the other segments. The
company's margins have deteriorated with the solar decline; the last-12-month
EBITDA margins were 7.4% as of June 30, 2012, down from 12.7% for the same
period ended June 2011.
Debt reduction in 2009 and 2010 (in part with proceeds from a 2009 equity
issuance), the recovery of cash collateral relating to the company's precious
metal leases, and the resulting significant reduction in interest expense all
contributed to Ferro's improved financial risk profile when compared with
2009. However, as a result of the significant drop in EBITDA over the past
year, credit metrics have weakened--a trend we expect to continue this year.
The ratio of FFO to total adjusted debt (adjusted for capitalized operating
leases, and underfunded pension and other postretirement obligations) was 23%
as of June 30, 2012, compared with 30% at the end of 2011. We believe
management will remain prudent in its capital spending plans and any potential
acquisitions or shareholder rewards, thereby maintaining a financial policy
that support our ratings.
We view Ferro's liquidity as "adequate." As of June 30, 2012, the company had
$25 million in cash and about $341 million available under its $350 million
revolving credit facility maturing in August 2015. The company also has a $50
million 364-day receivables securitization facility expiring in May 2013.
Ferro uses precious metals in the production of some of its products,
primarily silver for electronic materials products. It has about $350 million
in collateral free lease lines and did not have any cash on deposit as
collateral as of June 30, 2012.
We base our liquidity assessment on the following factors and expectations:
-- Sources of cash will exceed 1.2x of cash usage during the next 12 to
-- Sources will remain positive even in the event of a 20% EBITDA
-- Compliance with financial covenants could survive a 15% drop in
-- Ferro would likely be able to absorb low-probability shocks based on
available liquidity. We believe the company's flexibility to lower capital
spending or sell assets should supplement liquidity.
Debt maturities are limited for the next several years, with the next upcoming
maturity consisting of the remaining $34 million of convertible senior notes
due Aug. 15, 2013. We expect that the company will repay these notes through a
combination of free cash flow and revolver borrowings. In June 2012, the
company amended its financial covenants to provide additional flexibility.
Financial covenants now include a maximum leverage ratio of 4.25x in 2012 and
3.5x thereafter, as well as a maximum capital expenditure and minimum interest
coverage covenant. The minimum interest coverage covenant is 2.5x in the third
quarter of 2012, 2.75x in the fourth quarter, and 3.0x thereafter. Ferro
eliminated the minimum fixed-charge coverage ratio, which we believe was
problematic, as it had deducted capital expenditures from EBITDA in the
For the complete recovery analysis, see our recovery report on Ferro Corp.,
Ferro Corp.'s Recovery Rating Profile, published on May 17, 2012, on
The outlook is stable. Our base case assumes a significant drop in 2012
EBITDA, resulting from depressed demand for solar pastes, coupled with
continuing sluggish demand for residential and commercial building and
renovation, particularly in Europe. We expect that earnings will improve
modestly in 2013, albeit from very weak levels, as the company should benefit
from recent cost cutting initiatives. Based on our scenario forecasts, we
believe that 2012 free operating cash flow will be neutral, based on our
expectations that reduced capital expenditures and lower working capital needs
will offset lower earnings.
We could lower the ratings within the next 12 months if industry conditions or
the company's operating performance are below our expectations. This could
occur if the company is unable to successfully improve its position in the
Asian solar market, or if fierce competition continues to keep pricing down.
Based on our downside scenario, we could lower the ratings if revenues decline
by 15% and EBITDA margins decrease by 100 basis points or more below our
expectations. In such a scenario, FFO to total adjusted debt would decrease to
below 12%. We could also lower the ratings if free cash flow turns negative,
or if EBITDA cushions under the covenants decline to about 10%.
We could consider a one-notch upgrade if the macroeconomic outlook
strengthens, operating results stabilize, and we gain confidence that EBITDA
will moderately improve from weak 2012 levels. Specifically, we could consider
a modest upgrade if EBITDA margins improve by 150 basis points or more,
coupled with a 5% increase in revenues. In such a scenario, we expect that FFO
to total adjusted debt would increase to above 20%. The company's end-market
concentration in construction and electronics, which are cyclical and have
discretionary demand characteristics, could limit further upgrade potential if
the company does not take strategic actions to diversify and strengthen its
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,
May 27, 2009
-- Key Credit Factors: Methodology And Assumptions On Risks In The
Packaging Industry, Dec. 4, 2008
Corporate credit rating B+/Stable/-- BB-/Stable/--
Senior unsecured B- B
Recovery rating 6 6