-- U.S.-based Xerium Technologies Inc.'s operating performance has
weakened as a result of lower demand from European papermaking markets, and we
believe this softness is likely to continue over the next 12 months.
-- We are affirming our ratings on the company, including the 'B'
corporate credit rating.
-- At the same time, we are revising the outlook to negative from stable.
-- The negative outlook reflects our expectation that end markets and
operating performance are likely to remain weak in the near term.
On Nov. 20, 2012, Standard & Poor's Ratings Services revised its outlook on
Raleigh, N.C.-based paper product manufacturer Xerium Technologies Inc.'s
corporate credit rating to negative from stable. At the same time, we affirmed
the ratings on the company, including the 'B' corporate credit rating.
The negative outlook reflects our expectation that weak end markets,
especially in Europe where Xerium generates about 30% of its revenues, are
likely to continue to pressure Xerium's operating performance in 2013. We
believe volumes are tied to GDP growth, and we expect GDP in the eurozone to
contract 0.8% in 2012 and be flat in 2013. Despite cost reductions and
relatively better demand in Asia and America, the company may not be able to
maintain a comfortable level of headroom over its financial covenants if
European markets do not stabilize. Our forecast also assumes:
-- GDP growth in the U.S. of 2.1% in 2012 and 2.3% in 2013;
-- Mid-single-digit contraction in Xerium's top line in 2012 and no
growth in 2013;
-- High-teens EBITDA margin; and
-- Annual capital expenditures of about $30 million.
The ratings also reflect our view of Xerium's "weak" business risk profile and
"highly leveraged" financial risk profile. The business risk profile takes
into account the company's continued presence in the cyclical and competitive
market for papermaking products, limited end-user industry diversification,
and our expectation that structurally weak medium-term demand in mature
markets will likely continue to pressure prices for the company's products. In
our view, Xerium's relatively variable cost structure, sound margins, and fair
geographic diversification partly offset these weaknesses. Xerium's geographic
diversification should enable it to benefit from more positive industry
fundamentals in emerging markets.
The company generated revenues of $550 million in the 12 months ended Sept.
30, 2012. Xerium operates in two business segments: clothing, in the form of
synthetic textile belts that transport paper through papermaking machines, and
roll covers, which provide covering surface for large steel cylinders between
which paper travels. Clothing represents roughly 65% of revenue, and roll
covers make up the remainder. These consumables will continue to play key
roles in converting raw material into paper, and we expect customers to
continue to prefer local, long-standing suppliers that they believe are
reliable. The company has indicated that it derives about two-thirds of its
sales from products customers use in the production of high-growth paper
grades such as tissue, containerboard, and specialty paper. Newsprint and
printing paper grades represent the remaining sales; these are experiencing
low growth or contraction.
We expect the long-term shift of global production to Asia to continue, and,
in our view, this could cause production volumes in North America and Europe
to remain subdued. As a result, we believe pricing, although not the key
buying decision (given the product's critical nature and its low cost compared
with the total cost of papermaking), will remain highly competitive in these
markets. Xerium derives about 28% of its sales from Asia-Pacific and South
America, and it should benefit from higher growth rates in these regions.
However, the company does not currently have paper-machine clothing production
facilities in China, and this could constrain its ability to capitalize on
growth trends in this large market.
Xerium's adjusted operating margin (before depreciation and amortization), at
about 17% in the 12 months ended Sept. 30, 2012, has declined from about 21%
last year because of lower volumes in Europe. In our view, paper mill
closures, industry consolidation, and limited pricing power are likely to
continue to pressure Xerium's margins. However, we believe the company's
restructuring actions should enable it to prevent further decline in margins.
The company held margins in the high teens when revenue contracted by more
than 20% in 2009.
The capital structure reflects what we consider to be a highly leveraged
financial risk profile. Leverage, measured by adjusted total debt to EBITDA,
was about 5.5x as of Sept. 30, 2012. For the rating, we expect total debt to
EBITDA of 5x-6x. In our view, stable operating margins should contribute cash
flow sufficient enough to cover capital expenditures and working capital
requirements and also to support modest debt reduction. The ratings do not
account for large, debt-financed acquisitions, and such acquisitions could
result in our reviewing the ratings for a possible downgrade of the company.
We believe Xerium has adequate sources of liquidity to cover its needs in the
near term, even if EBITDA declines unexpectedly. The company has minimal
maturities over the intermediate term. Our assessment of Xerium's liquidity
profile incorporates the following expectations and assumptions:
-- We expect the company's sources of liquidity, including cash and
facility availability, to exceed its uses by 1.2x or more over the next 12 to
-- We expect net sources to remain positive, even if EBITDA declines more
-- We believe the company has the flexibility to reduce capital
expenditures by about $15 million.
-- We expect management to anticipate potential setbacks and take
necessary actions to ensure adequate liquidity.
Liquidity sources include our expectation of about $20 million in
discretionary cash flow in 2012 and 2013, access to its $30 million revolving
credit facility, and sufficient cash to cover operating needs and to
collateralize letters of credit. Uses of liquidity include roughly $30 million
in capital expenditures and minimal debt amortization.
We rate Xerium's senior secured credit facility 'BB-', with a recovery rating
of '1', indicating our expectation of a very high (90% to 100%) recovery in a
payment default scenario. We rate the company's unsecured notes 'B', with a
recovery rating of '4', indicating our expectation of average (30% to 50%)
recovery in a payment default. (See our recovery report on Xerium Technologies
Inc., published May 30, 2012 on RatingsDirect.)
The outlook is negative. We could lower the ratings if EBITDA declines and the
company does not reduce its debt, which could result in limited EBITDA
headroom over its financial covenants. Factors that could contribute to such a
scenario would be continued global economic weakness, increased pricing
pressures, and adverse foreign exchange movements. We could revise the outlook
to stable if operations stabilize and we expect the company to maintain
headroom of at least 15% over its covenants.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology and Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings Affirmed; Outlook To Negative
Xerium Technologies Inc.
Corporate Credit Rating B/Negative/-- B/Stable/--
Xerium Technologies Inc.
Senior Secured BB-
Recovery Rating 1
Senior Unsecured B
Recovery Rating 4
Xerium Technologies Ltd.
Senior Secured BB-
Recovery Rating 1
Complete ratings information is available to subscribers of RatingsDirect on
the Global Credit Portal at www.globalcreditportal.com. All ratings affected
by this rating action can be found on Standard & Poor's public Web site at
www.standardandpoors.com. Use the Ratings search box located in the left