The company’s end markets are steadily improving, and we anticipate that this will continue into next year, based on Standard & Poor’s outlook for modest U.S. economic growth in 2013. Given the company’s focus on shifting to a higher margin product mix, ongoing cost reduction initiatives, and new product introductions, earnings and EBITDA margins have meaningfully improved over the past year; the last-12-month EBITDA margins were 10.6% as of Sept. 30, 2012, up from 7.5% for the same period ended September 2011. Nonetheless, we expect the company’s operating performance will remain vulnerable to volatile input costs, including polyethylene and polypropylene resin costs, and to economic slowdowns and competitive pressures.
Intertape has midsize market shares in its niches, but it is not the largest player in many of its segments. The tapes market has only a few well-established players, including Intertape. Although competition can at times constrain pricing, the company benefits from the absence of severe price competition in most product categories. The company’s competitive position in its market niches and positive long-term growth prospects for industrial tape demand in North America partially mitigate weaknesses in its business risk profile. Tapes are the company’s largest business--in 2011 it accounted for 66% of revenues. Products mainly consist of carton sealing tapes, industrial tapes (including masking tape and duct tape), and water activated tape. The films business, which accounted for nearly 20% of 2011 revenues, complements the tapes business and uses the same distribution network that markets the majority of Intertape’s other products. The woven products business includes lumber wrap and house wrap for use in the housing construction market.
Liquidity is “adequate.” The company’s $200 million asset-based lending (ABL) revolving credit facility is a key source of liquidity. In February 2012, Intertape amended and extended the maturity of its ABL facility to 2017. In October 2012, Intertape issued a notice of redemption for $55 million of its outstanding senior subordinated notes due August 2014. We expect that this will be funded through a combination of free cash flow, revolver drawings, and proceeds from a new $17 million real estate secured term loan. Following this redemption, there will be about $39 million in subordinated notes outstanding, which we expect the company will repay or refinance over the next few quarters.
As of Nov. 6, 2012, the company reported cash balances and availability under the credit facility of about $108 million. The company’s applicable borrowing base--a percentage of eligible trade accounts receivable, inventories, and machinery and equipment--is used to determine the amount available to the company under the facility. As part of the amendment to the ABL, the reappraisal of machinery and equipment led to a modest increase in the company’s borrowing base. Although we expect the company’s earnings to be relatively stable over the next few quarters, unexpected shocks could pressure liquidity. The ABL facility is subject to a springing fixed-charge covenant of 1x, which is applicable only if availability is less than $25 million. The covenant has not been in effect in recent quarters, but the company reports that its fixed-charge ratio was greater than the 1x threshold at the end of September 2012. Based on our scenario forecasts, we expect that availability under the ABL will remain moderately above the $25 million threshold and therefore the company should not be subject to the springing covenant in the next few quarters.
Our assessment of liquidity reflects the following assumptions and analysis:
-- We expect the company’s sources of liquidity to exceed its uses by 1.2x or more over the next 12 to 24 months.
-- Net sources would be positive even with a 15% drop in EBITDA.
-- Based on our scenario forecasts, we expect free cash flow generation to be modestly positive over the next several quarters. Still, free cash flow has been erratic and the company remains vulnerable to volatile input costs.
-- We do not expect any meaningful increase in capital spending or any significant outflows on shareholder rewards, acquisitions, or growth initiatives.
Our issue-level rating on the company’s $125 million senior subordinated notes is ‘CCC+’ (two notches below the ‘B’ corporate credit rating), and the recovery rating is ‘6’, indicating our expectation of negligible (0% to 10%) recovery in the event of a payment default. For the complete recovery analysis, see our recovery report on Intertape Polymer U.S. Inc., published on May 30, 2012, on RatingsDirect.
The stable outlook reflects our expectation that Intertape will be able to at least maintain its improved operating performance over the next year based on Standard & Poor’s outlook for continued modest U.S. economic growth in 2013. We expect the company’s continued focus on shifting to a higher margin product mix, ongoing cost reduction initiatives, and new product introductions should allow it to maintain earnings and EBITDA margins at close to current levels. The outlook also reflects our view that positive free cash flow generation should continue to support the company’s adequate liquidity.
We could raise the ratings by one notch if Intertape is able to sustain its improved credit metrics, so that FFO-to-total debt remains above 20%, even after accounting for potential downturns. We could also consider a modest upgrade if free cash flow is greater than we expect, allowing the company to continue to reduce debt. Although less likely at this time given the strength exhibited by the company’s credit metrics, we could lower the ratings if the recent improvement in EBITDA reverses and free cash flow turns negative, causing liquidity to deteriorate. Based on our downside scenario, we could lower the ratings if the company can’t fully pass on escalating raw material prices to customers, causing EBITDA margins to deteriorate by 400 basis points or more from current levels. If this were to happen, we would expect that total adjusted debt to EBITDA would weaken to about 5x.
Related Criteria And Research
-- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Key Credit Factors: Methodology And Assumptions On Risks In The Packaging Industry, Dec. 4, 2008