Johannesburg, 30 April 2020 – GCR Ratings (“GCR”) has affirmed the national scale issuer ratings assigned to African Oxygen Limited of A+(ZA) and A1(ZA) for the long and short term respectively, with a Stable Outlook.
|Rated Entity / Issue||Rating class||Rating scale||Rating||Outlook / Watch|
|African Oxygen Limited||Long Term Issuer||National||A+(ZA)||Stable Outlook|
|Short Term Issuer||National||A1(ZA)|
The ratings on African Oxygen Limited (“Afrox” or “the company”) reflect the strong funding profile, underpinned by robust cash generation despite sustained weakness in the South African operating climate. GCR’s view is further supported by Afrox’s strongly entrenched market position and advantages of its integration into ultimate parent Linde plc (“Linde”), counterbalanced by relatively low product diversification and limited geographic diversification.
The company has sustained very conservative leverage levels over the years, with bank debt further reduced to R600m after settlement of the R400m tranche of a syndicated facility. With earnings growth continuing to sustain strong cash reserves (FY19: R1.2bn), Afrox is expected to sustain a strongly net ungeared position. Due to improvements in plant efficiency and reliability over the years, capital expenditure has been well-controlled and managed at levels marginally higher those sustained by global market leaders, ultimate parent Linde plc and Air Liquide. As such, spend for FY20 is expected to ease to c.5% of revenue, from historical levels of c.7.3%, with modest pickup thereafter.
In this regard, and in view of demonstrated rigour in the management of the working capital cycle, Afrox’s external financing requirements are not expected to change materially in the short-term. The company is expected to continue to leverage trade facilities to sustain its operations through the ongoing market disruptions, with timely settlement of these exposures, despite our expectation that the FY20 cash flows will be constrained by disruptions to downstream customers’ operations. Debt serviceability also remains very strong, with the company continuing to generate net interest income from its ample cash reserves. Discretionary cash flow coverage of debt (including finance leases) also picked up strongly, rising above 70.0x in FY19. Although GCR expects some short-term pressure on these metrics, robust coverage is projected through the cycle.
Afrox’s low leverage indicates sufficient room to more than double its debt before the existing facility covenants are impacted. That said, covenant risk could be amplified in the short-term by much weaker than anticipated earnings. Well-established relationships with strong funding counterparties also provide strong funding flexibility, and enabled the company to increase its facilities in order to further bolster liquidity during the period of uncertainty arising from COVID-19 restrictions. Given Afrox’s strong cash reserves, it is considered unlikely that these facilities will be drawn down unless the disruptions are significantly protracted. Accordingly, we expect the company’s cash and its stable base of recurring cash flows to support liquidity coverage of at least 2.0 times over next two years.
Our view on earnings is neutral, although GCR notes the sustainable margin enhancement achieved by rationalisation and efficiency enhancement. This has seen the EBIT margin trend between 10%-15% in recent years. GCR expects growth in higher margin volumes to sustain margins around the 15%-20% level in the medium term, closely aligning with global industry leaders. Cash conversion remains robust due to rigorous controls, translating to strong operating cash flows. Downside risks to our view could arise from restricted productivity in key sectors in the wake of the COVID-19 crisis. This could result in revenue falling below projections, and weaker than anticipated margin.
Although GCR is of the view that Afrox qualifies for limited group support, we have not made a positive adjustment in its score, as no capital injections from the ultimate parent have been necessary to date, and no financial support is likely to be required over the rating horizon. We have nonetheless noted that Afrox’s well-established position as a leading supplier of gases and welding products in the SADC region is underpinned by Linde’s strong technological and operational oversight, which has enhanced efficiency and plant reliability. Afrox’s control of the supply chain and its extensive distribution network, also further entrench its market position.
The Stable Outlook reflects GCR’s view that Afrox is well-positioned to withstand short-term earnings pressure, and that its funding and liquidity will continue to be managed at strong levels despite the contraction in cash reserves expected in FY20.
Upward rating action could be taken if the group continues to demonstrate low leverage, earnings resilience and strong liquidity, achieving EBIT margins at the upper end of the 15%-20% range. Conversely, significant volume pressure that leads to a sustained weakening in credit risk metrics or pressure on liquidity due to weak collections or sustainable short-term debt levels could result in negative rating action.
|Primary analyst||Patricia Zvarayi||Deputy Sector Head: Corporate Ratings|
|Johannesburg, ZA||patricia@GCRratings.com||+27 11 784 1771|
|Committee chair||Matthew Pirnie||Group Head of Ratings|
|Johannesburg, ZA||MatthewPGCRratings.com||+27 11 784 1771|
Related Criteria and Research
|Criteria for the GCR Ratings Framework, May 2019|
|Criteria for Rating Corporate Companies, May 2019|
|GCR Rating Scales, Symbols and Definitions, May 2019|
|GCR Country Risk Scores, January 2020|
|GCR Corporate Sector Risk Scores, March 2020|
African Oxygen Limited
|Rating class||Review||Rating scale||Rating class||Outlook||Date|
|Long Term Issuer||Initial||National||A+(ZA)||Stable||Sep 2001|
|Short Term Issuer||Initial||National||A1(ZA)|
|Long Term Issuer||Last||National||A+(ZA)||Stable||July 2019|
|Short term Issuer||Last||National||A1(ZA)|
RISK SCORE SUMMARY
|Country risk score||7.00|
|Sector risk score||4.00|
|Management and governance||0.00|
|Leverage and capital structure||2.00|
|Total Risk Score||15.00|
|Cash Flow||The inflow and outflow of cash and cash equivalents. Such flows arise from operating, investing and financing activities.|
|Cash||Funds that can be readily spent or used to meet current obligations.|
|Conditions||Provisions inserted in an insurance contract that qualify or place limitations on the insurer’s promise to perform.|
|Covenant||A provision that is indicative of performance. Covenants are either positive or negative. Positive covenants are activities that the borrower commits to, typically in its normal course of business. Negative covenants are certain limits and restrictions on the borrowers’ activities.|
|Coverage||The scope of the protection provided under a contract of insurance.|
|Debt||An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.|
|Diversification||Spreading risk by constructing a portfolio that contains different exposures whose returns are relatively uncorrelated. The term also refers to companies which move into markets or products that bear little relation to ones they already operate in.|
|Exposure||Exposure is the amount of risk the holder of an asset or security is faced with as a consequence of holding the security or asset. For a company, its exposure may relate to a particular product class or customer grouping. Exposure may also arise from an overreliance on one source of funding. In insurance, it refers to an individual or company’s vulnerability to various risks|
|Income||Money received, especially on a regular basis, for work or through investments.|
|Interest Cover||Interest cover is a measure of a company’s interest payments relative to its profits. It is calculated by dividing a company’s operating profit by its interest payments for a given period.|
|Interest||Scheduled payments made to a creditor in return for the use of borrowed money. The size of the payments will be determined by the interest rate, the amount borrowed or principal and the duration of the loan.|
|Issuer||The party indebted or the person making repayments for its borrowings.|
|Leverage||With regard to corporate analysis, leverage (or gearing) refers to the extent to which a company is funded by debt.|
|Liquidity||The speed at which assets can be converted to cash. It can also refer to the ability of a company to service its debt obligations due to the presence of liquid assets such as cash and its equivalents. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price.|
|Long Term Rating||See GCR Rating Scales, Symbols and Definitions.|
|Market||An assessment of the property value, with the value being compared to similar properties in the area.|
|Offset||A right (Right of Offset) to set liabilities against assets in any dispute over claims.|
|Operating Cash Flow||A company’s net cash position over a given period, i.e. money received from customers minus payments to suppliers and staff, administration expenses, interest payments and taxes.|
|Rating Outlook||See GCR Rating Scales, Symbols and Definitions.|
|Reserve||(1) An amount representing actual or potential liabilities kept by an insurer to cover debts to policyholders. (2) An amount allocated for a special purpose. Note that a reserve is usually a liability and not an extra fund. On occasion a reserve may be an asset, such as a reserve for taxes not yet due.|
|Reserves||A portion of funds allocated for an eventuality.|
|Risk||The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.|
|Short Term Rating||See GCR Rating Scales, Symbols and Definitions.|
|Short Term||Current; ordinarily less than one year.|
|Upgrade||The rating has been raised on its specific scale|
SALIENT POINTS OF ACCORDED RATINGS
GCR affirms that a.) no part of the rating process was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the validity of the ratings is for a maximum of 12 months, or earlier as indicated by the applicable credit rating document.
The credit ratings have been disclosed to African Oxygen Limited. The ratings above were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings.
African Oxygen Limited participated in the rating process through management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from African Oxygen Limited and other reliable third parties to accord the credit ratings included:
- The audited financial results for December 2019
- Four years of comparative audited numbers
- Industry presentation for 2019
- Details on capital and operational expenditure commitments