Wendel’s investment portfolio was worth about EUR8.5 billion on Oct. 17, 2012 (using spot prices to value traded assets and assuming flat unlisted values compared with those on Aug. 21, 2012, when the company last reported). It mainly includes three listed assets representing some 90% of its value: testing, inspection, and certification company Bureau Veritas (not rated); building materials producer and distributor Compagnie de Saint-Gobain (BBB/Stable/A-2); and electrical and digital equipment manufacturer Legrand S.A. (A-/Stable/A-2). Majority stakes in smaller, more leveraged unlisted corporate entities round out the company’s portfolio.
We believe that Wendel’s financial flexibility is still stretched and that the main rating constraint remains its aggressive financial risk profile. At holding company level, relative to the estimated value of the asset portfolio, Wendel’s loan-to-value (LTV) ratio was about 38% on Oct. 17, 2012, by our calculations (assuming stable net debt compared with the Aug. 21, 2012, figure). A portion of the shares held in Saint-Gobain, Legrand, and Bureau Veritas (worth more than EUR1 billion according to our calculations) are still pledged to secure EUR0.8 billion of Saint-Gobain-related bank debt. In addition, we note that cash burn remains significant at holding-company level, with total coverage of fixed charges by dividends of only about 0.5x in 2009-2011.
Partially offsetting these weaknesses is the generally good creditworthiness of the larger assets in Wendel’s portfolio, and their listed, potentially liquid nature; and management’s ability to rotate assets, extracting value out of its investments to reduce leverage.
Key portfolio developments
In the first half of 2012, the performance of Wendel’s companies that are exposed to construction markets largely reflected the sector’s difficult economic environment and rising input prices. Conversely, Bureau Veritas, high-performance coatings and leather finishing products manufacturer Stahl (not rated), and the Oranje-Nassau Developpement companies posted resilient to strong figures for the period.
Since its sale of electrical connections provider Deutsch Group SAS (Deutsch), Wendel has indicated it is examining a number of acquisition opportunities, with no investment activity so far, at the time of publication. Given the scale of contemplated targets (for up to EUR500 million, primarily in unlisted assets), we expect the portfolio composition to remain largely unchanged--with stable liquidity, quality, and diversity descriptors as per our methodology.
S&P base-case cash flow and capital-structure scenario
Wendel’s LTV ratio of 38% on Oct. 17, 2012, by our calculations, was well placed compared with our expectation of 45% for the ratings. On that date, it would have taken an overall decline in asset value of about 15% for our threshold to be met. We understand that Wendel will reinvest part of the Deutsch proceeds. We estimate that EUR100 million reinvested would increase LTV by about 0.7%.
In 2012 we believe cash burn, which was about EUR170 million in 2011, should decrease at holding company level and improve progressively toward breakeven thereafter. We forecast lower financing costs of about EUR200 million as a result of reduced debt and lower negative carry. We anticipate that Wendel will contain its operating costs at around EUR50 million and keep returns to its shareholders at levels broadly comparable to those in the past few years (meaning well below EUR100 million). In addition, we believe that Bureau Veritas and Saint-Gobain, which are the two largest dividend contributors, should maintain generally stable payouts in terms of dividend per share, and that dividend income should total approximately EUR200 million per year. As a result, we expect total coverage (the ratio of dividends received to operating and net interest expenses plus dividends paid at holding company level) to be above 0.7x in 2012 and to be strengthening by about 0.1x in 2013.
The short-term rating is ‘B.’ We assess Wendel’s liquidity as “adequate” under our criteria, with sources of liquidity to cover well above 1.2x of its needs in the next twelve months, even in the event of unforeseen decline in dividends from portfolio companies.
On Aug. 21, 2012, Wendel’s liquidity sources included:
-- Net cash and cash equivalents close to EUR1.3 billion, pro forma for the seven-year, EUR400 million bond issued on Sept. 17, 2012;
-- Dividends from portfolio companies of close to EUR200 million to be received in 2013, by our estimates; and
-- EUR950 million undrawn under Wendel’s EUR1.2 billion syndicated revolving credit facility (RCF), of which EUR950 million is available until September 2013 and EUR250 million until September 2014. Based on share prices on Oct. 17, 2012, we believe covenants on the facility leave adequate headroom. If asset values were to decline and jeopardize covenant compliance, the company could repay the EUR250 million drawdown if needed. This is because it also has about EUR1.2 billion undrawn under a number of Saint-Gobain financing-related facilities, of which EUR225 million is available until 2016, and EUR925 million until 2017 (including EUR225 million and a EUR700 million facility put in place earlier this year in July). We understand that the documentation of these facilities would allow any utilization to refinance part of the currently unpledged Saint-Gobain shares, which account for about three-quarters of the total.
In the absence of short-term debt, uses of funds in the 12 months to August 2013 should amount to about EUR350 million.
-- They will include operating expenses of below EUR50 million, dividend payments comparable to the amount distributed in 2012, and interest expenses of about EUR200 million, and some share repurchases.
-- Wendel will face large maturities in 2014, when EUR644 million in bonds and EUR250 million of its RCF come due. Our liquidity assessment incorporates our expectation that Wendel will tackle the refinancing of these maturities well in advance, as per its policy of maintaining well spread out debt maturities.
Wendel’s EUR3.1 billion senior unsecured notes and EUR1.2 billion unsecured RCF are rated ‘BB’, the same level as the corporate credit rating. The recovery ratings on these instruments are ‘3’, indicating our expectation of meaningful (50%-70%) recovery in the event of a payment default. In accordance with our criteria, although recovery prospects exceed the 50%-70% range, the recovery ratings on the unsecured notes are capped at ‘3’.
The recovery ratings are supported by our view of Wendel’s portfolio, based on its three largest companies that we consider robust. Constraints are the possibility of prior ranking debt linked to the Saint-Gobain acquisition (EUR825 million is currently outstanding after the massive repayments made since 2009), and our opinion that France’s jurisdiction is less creditor friendly than other countries’. In particular, the recovery ratings on the unsecured debt, comprising the notes and the RCF, are also constrained by their unsecured nature. We assume that the notes and the RCF rank pari passu.
Recovery prospects are supported by our assumption that Wendel would be liquidated if it defaulted, given the good liquidity of its portfolio, about 90% of which is composed of listed companies. To determine recoveries, we simulate a default scenario. Based on the assumptions below, Wendel would hypothetically default in late 2014, owing to its inability to refinance the second tranche of its unsecured RCF and its EUR644 million in unsecured bonds. Among other things, we envisage under our simulation that the portfolio value will lose about 50% from the level reported on Aug. 21, 2012, combined with a pronounced decrease in dividend inflows. The company, on the path to default, will partially use up its existing cash balances to meet cash flow shortfalls, additional equity investment requirements in existing portfolio companies, and the repayment of a tranche of its RCF in 2013.
Wendel is based and headquartered in France. We consider France to be a less creditor friendly jurisdiction for senior secured creditors than other countries. We estimate a stressed portfolio value at the point of default of about EUR4.4 billion including residual cash. After deducting priority liabilities of EUR1.0 billion, comprising mainly enforcement costs and debt related to the acquisition of Saint-Gobain shares still outstanding at that time, we arrive at a net stressed value of EUR3.4 billion. At default, we assume around EUR3.4 billion of unsecured debt outstanding, including the unsecured notes, the second tranche of the RCF outstanding, and six months of prepetition interest.
The recovery ratings on the unsecured debt are ‘3’, indicating our expectation of average (50%-70%) recovery for debtholders in the event of a payment default. In accordance with our criteria, the recovery ratings on the unsecured debt instruments are capped at ‘3’, although recovery prospects exceed the 50%-70% range. Under our criteria, for unsecured debt issued by corporate entities with a corporate credit rating of ‘BB-’ or higher, we generally cap recovery ratings at ‘3’. This takes into account the greater risk of impairment to our recovery prospects that would result from issuing additional priority loans, for example bank loans, as they are not covered by the negative pledge clause in the documentation or by pari-passu debt prior to default.
The stable outlook reflects our expectation that, based on current portfolio composition and asset flexibility, Wendel should be able to maintain an LTV ratio below 45%, and adequate liquidity.
Significant deterioration in the share prices of Wendel’s key listed investments or a financial policy more aggressive than we currently expect could lead us to consider a negative rating action. Deteriorating liquidity to below our “adequate” category would put pressure on the ratings, although we consider this as an unlikely scenario for the near future.
We might consider a positive rating action, assuming broadly unchanged portfolio liquidity, quality, and diversity, if we saw that the company had established a track record of an LTV ratio below 40% and appeared able to maintain it. A further prerequisite would also be a significant reduction in cash burn at holding company level. We would also examine the operating performance of Wendel’s main subsidiaries and would expect acquisitions to be pre-financed by disposals to a large extent.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers’ Speculative-Grade Debt, Aug. 10, 2009
-- Debt Recovery For Creditors And The Law Of Insolvency In France, March 22, 2007