(The following statement was released by the rating agency)
Dec 21 -
Summary analysis -- Vallourec ------------------------------------- 21-Dec-2012
CREDIT RATING: BBB+/Negative/A-2 Country: France
Primary SIC: Pipelines, nec
Mult. CUSIP6: 92023R
Credit Rating History:
Local currency Foreign currency
10-Nov-2011 BBB+/A-2 BBB+/A-2
The ratings on France-based seamless steel tube producer Vallourec reflect Standard & Poor’s Ratings Services’ view of the company’s business risk profile as “satisfactory” and its financial risk profile as “intermediate.”
Vallourec’s business risk profile is supported by our view that the company will maintain its strong market positions in the concentrated premium steel pipes and connections for the oil and gas industry, which accounted for about 60% of Vallourec’s first-nine months 2012 sales and a higher share of profits. We think the premium market, dominated by three players, will grow markedly in the next five years, while barriers to entry will remain high. Increasing hydrocarbon production in complex areas, such as shale and off-shore, imposes stringent requirements. We also factor in Vallourec’s elevated profitability across industry cycles based on its EBITDA amounts and, margins (after maintenance capital expenditure ), and geographic diversification. Other key strengths include vertical integration into steel production covering 80% of needs, and full integration in Brazil where the company owns iron ore mine and eucalyptus plantations for charcoal production.
The main constraints on Vallourec’s business risk profile are the volatility of earnings, prompted by industry cyclicality (swings in supply/demand balance), competition, capital intensity and long-lead time to add capacity, and exposure to raw materials price volatility outside Brazil.
Our assessment of Vallourec’s financial risk profile is underpinned by historically conservative financial policies, as illustrated by low net debt, prudent liquidity management, and our base-case assumption that Standard & Poor’s adjusted credit metrics for the company will improve by end 2014 to become rating-commensurate. Decreasing capex and expanding profits should help lift FFO to debt to 40% or more as of 2014.
The main constraints in our assessment are two large investments (in Brazil and the U.S.), which have resulted in weaker 2012 credit metrics than we anticipated and are unlikely to generate, in aggregate, positive free operating cash flow (FOCF) before 2014. These projects represent a large EUR2 billion investment.
S&P base-case operating scenario
We anticipate EBITDA around EUR0.7 billion-EUR0.8 billion in 2012, with EUR0.55 billion achieved in the first nine months. This would represent a 15%-25% decline compared with the close to EUR0.95 billion posted in 2011.
In our base case, we forecast the company’s EBITDA margin will recover in 2012 to slightly below 15%, from a low of 12.7% in the first quarter. That said, this margin remains below 2011 levels of 18% and far short of that of Luxembourg-domiciled Tenaris (not rated), the largest industry player, which reported a 27% EBITDA margin in the first nine months of this year.
We foresee an uptick in Vallourec’s EBITDA in 2013, to slightly above EUR0.95 billion, as its new Brazilian and U.S. plants ramp up in line with the company’s business plan. The U.S. plant should deliver positive EBITDA, while we assume losses at the Brazilian site will disappear in the second half of 2013. We also anticipate in Brazil that product certification by customers --necessary to deliver high-margin, premium products-- will be completed in the first half of 2013.
We assume continued robust demand in the oil and gas market, given continuously hefty investments in the industry amid high hydrocarbon prices and a favorable outlook. However, we don’t foresee an upswing in Vallourec’s profits in the European industrial segment owing to competition and lackluster demand.
S&P base-case cash flow and capital-structure scenario
We anticipate a marked decline in our adjusted ratio of funds from operations (FFO) for Vallourec in 2012 versus historical levels. We think the ratio will be weak for the rating in 2012, at about 30%, before recovering to 35% in 2013 and 40% or more in 2014. FFO to debt was 45% in 2011, more than 110% in 2010, and Vallourec had a largely net cash position in 2009.
Vallourec’s likely lower EBITDA, capex of EUR0.8 billion, and working capital outflow near EUR0.15 billion under our base case for 2012 contribute to the expected deterioration in FFO to debt. We also expect the company’s FOCF to remain negative in 2013. On the upside, capex should shrink to EUR650 million in 2013, as expansion plans near completion.
As a result, we expect Vallourec’s adjusted debt to EBITDA to remain in the 2.0x-2.5x range in 2012 and 2013.
From 2014, in our base case, we project positive discretionary cash flow as growth capex moderates and EBITDA increases.
The short term rating is ‘A-2’.
We view Vallourec’s liquidity as “strong”, as defined by our criteria. We expect liquidity sources to uses to comfortably exceed 1.5x in the 12 months from Sept. 30, 2012, when netting commercial paper debt from surplus cash.
We factor in the following sources of liquidity during this period:
-- EUR0.85 billion of available cash on Sept. 30, 2012, after excluding $0.1 billion of cash that we see as tied to operations.
-- EUR1.6 billion of credit line availability, which includes a EUR1.0 billion committed syndicated line maturing in February 2016 and EUR0.6 billion of bilateral revolving lines maturing in 2014 and 2015.
-- FFO close to EUR0.7 billion.
The main uses of liquidity in our scenario include:
-- Short-term debt of EUR1.2 billion, of which EUR0.6 billion relating to drawings under the EUR 1 billion commercial paper (CP) program.
-- Capital spending of EUR0.7 billion.
-- Dividends of EUR0.1 billion, in line with the company’s 33% payout policy.
-- Working-capital outflows above EUR0.2 billion.
We expect the company to maintain ample headroom under its financial covenant that limits net debt to equity to 75% at the end of each year. This ratio was 35% on Sept. 30, 2012.
The negative outlook on Vallourec reflects the possibility of a downgrade within 12 months if we saw deviations to our base-case scenario, including a lack of improvement in the company’s EBITDA and credit metrics in 2013 and 2014, and FFO to debt staying below 35%. This potential underperformance could occur owing to rising project costs, fresh profit warnings, or industry conditions weaker than we currently anticipate.
We would revise the outlook to stable if we saw tangible signs that Vallourec’s 2013-2014 credit ratios and EBITDA would recover in line with our base case, helped to a large degree by good progress at its two new plants. We see FFO to debt of 35% in 2013--given the large investment phase--and 40% thereafter, as commensurate with the ratings on Vallourec.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Criteria Methodology: 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
-- How U.S. Exploration & Production Companies Are Coping With Low Gas Prices, June 5, 2012
-- Industry Report Card: For U.S. Oilfield Services And Contract Drilling Companies, Ratings Should Remain Stable In 2012, May 1, 2012
-- Industry Report Card: U.S. Exploration And Production Companies Draw Stability From High Oil Prices, April 18, 2012
-- Standard & Poor’s Raises Its Oil Price Assumptions; Natural Gas Price Assumptions Unchanged, March 22, 2012