|Rated Entity / Issue||Rating class||Rating scale||Rating||Outlook / Watch|
|Sappi Southern Africa Limited||Long Term Issuer||National||AA(ZA)||Stable Outlook|
|Short Term Issuer||National||A1+(ZA)|
GCR considers Sappi Southern Africa Limited (“SSA” or “the company”) an essential operating entity of Sappi Limited (“Sappi” or “the group”). This reflects Sappi’s 100% ownership of the company, operational integration, and SSA’s history of strong cash generation. Accordingly, SSA’s ratings are underpinned by Sappi’s entrenched competitive position globally, its strong access to capital, and robust liquidity. Counterbalancing these strengths is Sappi’s increasing leverage and its highly cyclical cash flows.
Despite the interim compression in cash flows, liquidity remains a positive rating factor, with Sappi’s 12 months’ uses versus sources coverage at a sound c.2.0x. At 1H FY20, liquidity was anchored by USD642m in unutilised, committed revolving facilities, and USD268m in cash (FY19: USD393m) across the group. Sappi continues to leverage its strong international access to capital to sustain a long-term debt maturity profile, which notably eases liquidity pressure.
Covenant risk has been reduced by relaxation of group leverage limits by Sappi Papier Holding GmbH (“SPH”) funders until December 2022. In addition, banks have agreed to waive group covenants until 1H FY21, although this is contingent on certain negative pledges. Looking ahead, we would expect Sappi to continue to proactively manage covenant risk over the outlook period.
The negative earnings assessment reflects the volatility in group margins due to the over-reliance on dissolving wood pulp (‘DWP’) for cash flows. Following robust performance in recent years DWP prices have been close to all-time lows since June 2019. 1H FY20, this drove a sharp decline in DWP earnings (>75% YoY), and a 30% contraction in group EBITDA despite the contribution from the newly acquired Matane Mill. In addition, COVID-19 related international disruptions have delayed the expected upturn in pulp prices, and also led to order cancellations/limited new contracts from the end of March 2020. Despite the uptick in packaging and specialties profits, GCR is thus factoring a material deterioration in profitability in FY20, but a recovery from FY21 post the COVID-19 disruptions. Overall, GCR has taken a through-the-cycle view of earnings, but a delayed market recovery which sees material earnings pressure persist well into FY21 would further weaken our assessment.
The leverage assessment has been adversely impacted by elevated industry uncertainty. Worse than projected market weakness saw debt to EBITDA spike to 3.5x at 1H FY20, ahead of our expectations of 2.5x-3.0x. Should margins remain close to interim levels, the metric could migrate into the 3.5x-4.5x range in the short term, although we expect it to be managed down to between 2.2x-3.0x thereafter. We have noted interventions to manage down debt, which include releasing cash from the working capital cycle and a sharp reduction in capex. GCR is also of view that the dividend moratorium will be extended beyond 1H FY21 if market uncertainty persists.
Operating cash flow coverage of debt is especially weak during the group’s capital investment cycles, and registered within the 20%-25% range in 1H FY20. We expect the metric to deteriorate further this year, and notwithstanding stronger cash flows expected over the rating horizon, coverage will likely remain constrained until the group begins to settle some of its legacy EUR-denominated debt. However, despite easing to 6.3x cover in 1H FY20, Sappi’s interest (cash interest cover: 7.5x), remains strong and is expected to remain at similar levels at year-end. Despite the material pickup in earnings expected for FY21, the metric is projected to remain within the 5.0x to 10x range over the rating horizon
Sappi’s competitive position is anchored by the global reach of its products, and its extensive capacity, with low-cost plants in Europe, North America and South Africa. Operational integration, strong supply chain efficiencies and ESG initiatives also mitigate the impact of currency risk and price volatility on group margins. Nevertheless, its credit risk profile remains susceptible to global pulp price dynamics, the structural decline of legacy paper products, and constrained demand in certain overseas markets.
The Stable Outlook reflects expectations that the group’s firm liquidity profile provides sufficient resilience to withstand short-lived pressure on cash generation amidst a capital investment cycle.
Negative rating action could derive from a deterioration in the group credit risk profile because of 1) COVID-19 related disruptions that are more severe than anticipated 2) Persistent pulp pricing pressure because of inherent market imbalances 3) elevated group leverage metrics beyond FY20 3) delays or cost overruns to major capex projects that impact the financial position.
Positive rating action is not considered likely until 1) ongoing capital projects are completed and fully bedded down and 2) Sappi demonstrates strong medium-term earnings growth and diversification, underpinned by higher margin packaging and specialties’ products.
|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||matthewp@GCRratings.com||+27 11 784 1771|
Related Criteria and Research
|Criteria for the GCR Ratings Framework, May 2019|
|GCR Rating Scales, Symbols and Definitions, May 2019|
|Criteria for Rating Corporate Companies, May 2019|
|GCR Country Risk Scores, May 2020|
|GCR Corporate Sector Risk Scores, March 2020|
Sappi Southern Africa Limited
|Rating class||Review||Rating scale||Rating class||Outlook||Date|
|Long Term Issuer||Initial||National||A(ZA)||Stable||November 2015|
|Short Term Issuer||National||A1(ZA)|
|Long Term Issuer||Last||National||AA(ZA)||Stable||November 2019|
|Short Term Issuer||National||A1+(ZA)|
RISK SCORE SUMMARY
|Rating Factors and Sub-factors||Risk Scores|
|Country risk score||11.50|
|Sector risk score||5.25|
|Management and governance||0.00|
|Leverage and cash flow||-1.75|
|Sappi Limited Total Risk Score||17.25|
|Essential subsidiary adjustment||-1.00|
|Sappi Southern Africa Limited Total Risk Score||16.25|
|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.|
|Credit Rating||See GCR Rating Scales, Symbols and Definitions.|
|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|
|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.|
|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.|
|Long Term Rating||See GCR Rating Scales, Symbols and Definitions.|
|Rating horizon||The rating outlook period, typically 18 to 24 months.|
|Short Term Rating||See GCR Rating Scales, Symbols and Definitions.|
|Short Term||Current; ordinarily less than one year.|
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; and c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument.
The credit ratings have been disclosed to Sappi Southern Africa 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.
Sappi Southern Africa Limited participated in the rating process via face-to-face 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 Sappi Southern Africa Limited and other reliable third parties to accord the credit ratings included:
- audited financial results for Sappi Limited for 2019, and comparative historical audited financial statements;
- unaudited financial results for Sappi Limited for 1H 2020;
- audited financial results for Sappi Southern Africa Limited for 2019, and four years comparative financial statements;
- details of funding facilities; and
- group presentations.