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TEXT-S&P revises Xerium Technologies outlook to negative
November 20, 2012 / 7:45 PM / 5 years ago

TEXT-S&P revises Xerium Technologies outlook to negative

Overview
     -- 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.

Rating Action
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.

Rationale
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.

Liquidity
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 
18 months.
     -- We expect net sources to remain positive, even if EBITDA declines more 
than 15%.
     -- 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.

Recovery analysis
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.)

Outlook
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 List
Ratings Affirmed; Outlook To Negative 
                                        To                 From
Xerium Technologies Inc.
 Corporate Credit Rating                B/Negative/--      B/Stable/--

Ratings Affirmed

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 
column.

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