-- Carbon and graphite manufacturer GrafTech International Ltd. intends
to issue $300 million of new senior unsecured notes due 2020. The company
expects to use the proceeds to reduce its outstanding revolver borrowings.
-- We are assigning a 'BB+' issue-level rating to the proposed $300
million senior unsecured notes with a recovery rating of '4'. At the same
time, we are affirming our 'BB+' corporate credit rating on GrafTech.
-- The stable rating outlook reflects our expectation that GrafTech's
credit metrics will likely remain at levels that we would consider to be in
line for the rating despite the weakness in its European business.
On Nov. 13, 2012, Standard & Poor's Ratings Services assigned its 'BB+'
issue-level rating (same as the corporate credit rating) to Parma, Ohio-based
GrafTech International Ltd.'s proposed $300 million senior unsecured notes due
2020. The recovery rating on the notes is '4', indicating our expectation for
average (30%-50%) recovery in the event of a payment default.
At the same time, we affirmed our 'BB+' corporate credit rating on GrafTech.
The outlook is stable.
We expect the company to use the proceeds from the proposed issuance to repay
part of its outstanding revolver balance.
The rating affirmation and stable outlook reflect our expectation that the
average price of graphite electrodes, the company's primary product, will be
up about 11% to 12% in 2012, based on current market prices. This is despite
our expectations that sales volumes will decline because customers are
destocking, a consequence of the decline in steel production due to the
slower-than-anticipated economic recovery. We expect slightly higher revenues
and electrode volumes in 2013, in line with our forecasts of 1.8% GDP growth
in the U.S. and no growth in the Eurozone. Therefore, we expect GrafTech will
generate about $270 million in EBITDA in both 2012 and 2013. Consequently, we
expect debt-to-EBITDA to remain below 2.5x and funds from operations
(FFO)-to-debt about 30%--levels we consider commensurate with our view of the
company's "intermediate" financial risk.
The ratings on GrafTech reflect the combination of what Standard & Poor's
considers to be the company's "fair" business risk and "intermediate"
financial risk profiles. The ratings also reflect the company's significant
exposure to the cyclical steel industry, a high degree of supplier
concentration, and continued raw material cost pressures. Still, the company
maintains a good market position in graphite electrodes and has consistently
generated healthy operating margins. In addition, during the past several
years, the company has materially reduced its book debt through free cash flow
generation, which has resulted in an intermediate financial risk profile.
GrafTech manufactures carbon-based materials for use in various industrial
applications. Its industrial materials segment, which includes the graphite
electrodes business, accounts for over 90% of operating income. Graphite
electrodes are primarily used in electric arc furnaces, making the company
vulnerable to the cyclical steel industry. It also contributes to volatile
performance and cash flows.
GrafTech, and the graphite electrode industry as a whole, faces significant
raw material costs, particularly for needle coke, a key component of these
electrodes. Despite the company's ongoing cost-reduction initiatives,
GrafTech's average manufacturing cost for graphite electrodes has increased in
the past several years. Needle coke producers have pricing power because there
is a relatively constrained supply. We believe cost pressures will likely
continue for GrafTech, although its acquisition of Seadrift Coke L.P. does
provide some insulation. We believe GrafTech will eventually source as much as
50% of its needle coke needs internally.
GrafTech has a supply agreement with ConocoPhillips through December 2013 for
the needle coke it needs to produce its electrodes. Despite cost increases,
GrafTech has generated good margins on its electrode sales, resulting in
firmwide EBITDA margins of more than 20% in each of the past three years; we
expect this trend to continue.
We view GrafTech's liquidity profile as "adequate." Our view of the company's
liquidity profile incorporates the following expectations:
-- Sources of cash will exceed uses by more than 1.2x over the next 12
-- Sources of cash will be greater than uses even if EBITDA declines by
-- There is sufficient headroom under the company's covenants for EBITDA
to decline by 20% without causing the company to breach its financial
As of Sept. 30, 2012, the company had total liquidity, pro forma for the
transaction, of about $428 million, consisting of about $16 million in balance
sheet cash and $412 million of availability on its $570 million revolving
credit facility due 2016. The company expects capital spending of about $125
million in 2012, about 15% less than it spent in 2011, to fulfill its
maintenance requirements at existing facilities. We expect free operating cash
flow (FOCF) to be about negative $30 million in 2012 as the slowdown in the
Eurozone causes working capital to be a $75 million use of cash, primarily
from higher than expected levels of inventory due to lower sales volumes. We
expect 2013 FOCF to be positive, assuming capital spending is in the $150
million area and a decline in inventory levels to more normalized amounts,
causes working capital to be a source of cash of about $40 million.
As of Sept. 30, 2012, pro forma for the transaction, the company was in
compliance with covenants governing its bank credit facilities, which include
a senior secured leverage covenant of 2.25x and an interest coverage covenant
of 3x. Given our operating assumptions, we expect continued compliance with
these covenants with at least a 20% cushion. Near-term debt maturities in the
capital structure are minimal until 2015, when the company's $200 million in
senior subordinated notes mature.
GrafTech did not pay any cash dividends in 2011, and the company has no plans
to pay any cash dividends in the near future. The company maintains a share
repurchase program authorization for up to 10 million shares. We expect that
purchases under the new program may take place from time to time in the open
market or through privately negotiated transactions, as conditions warrant. We
would consider, debt-financed share repurchases an increase in credit risk.
The issue-level rating on GrafTech's proposed $300 million senior unsecured
notes due 2020 is 'BB+' (same as the corporate credit rating) with a recovery
rating of '4', indicating our expectation for average (30%-50%) recovery in
the event of a payment default.
The stable rating outlook reflects our expectation that GrafTech's credit
metrics are likely to remain at levels that we would consider to be in line
for the rating despite the weakness in the company's European business.
Specifically, we expect debt-to-EBITDA of about 2.5x and FFO-to-debt of about
30%. These metrics are driven by our expectation that prices for electrodes
will increase by 11%-12%, despite a decline in steel production due to the
slower-than-anticipated economic recovery.
We could downgrade the company if GrafTech generates materially
weaker-than-expected operating results, due to lower volumes sold from
declining steel production, assumes significantly more debt to fund additional
acquisitions or share repurchases, or credit metrics deteriorate beyond our
expectations. Specifically, we could lower the rating if debt leverage
increases and is sustained above 3x, which could occur if gross margins
unexpectedly decline to less than 23%.
An upgrade seems less likely any time soon, given our assessment of the
company's fair business risk profile. We believe that raising the rating would
likely require a strengthening of the company's business risk profile through
growth and significantly improved end-market diversification without any major
increase in debt.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,
Sept 18, 2012
-- Key Credit Factors: Methodology And Assumptions On Risks In The Metals
Industry, June 22, 2009
GrafTech International Ltd.
Corporate Credit Rating BB+/Stable/--
GrafTech International Ltd.
US$300 mil 5.75% nts due 11/15/2020 BB+
Recovery Rating 4