|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. SSA’s ratings are underpinned by Sappi’s entrenched global competitive position, its solid access to capital, and robust liquidity. Counterbalancing these strengths are Sappi’s cyclical cash flows and the deterioration in credit metrics due to earnings pressure in the wake of the COVID-19 pandemic.
Contributing to the negative earnings assessment, was the 20% contraction in in group revenue to USD4.6bn at FY20 (FY19: USD5.7bn), and the larger 45% decline in EBITDA to USD378m (FY19: USD687m). This as the EBITDA margin halved to 6.1% at Y20, from 12% at FY19. These downward trends resulted from a combination of pre-existing pricing pressure for dissolving wood pulp (“DWP”), thereafter exacerbated by the impact of the COVID-19 pandemic. Global demand for graphic paper and DWP were negatively impacted, leading to weaker volumes and significantly lower sales prices during 2H FY20. The lower DWP volumes intensified an already tough operating environment for the segment, and the historic low pricing levels persisted throughout the year. That said, underlying demand in respect of the packaging and speciality papers segment remained resilient, evidencing growth both in volumes and profitability, a trend that looks likely to continue over the rating horizon.
Positively, results for 1H FY21 reflect a marked recovery in the DWP market, with customer demand currently exceeding capacity and market prices having risen to a multi-year high. While the material price recovery will only be realised in subsequent quarters due to the lag in contractual pricing, improved pricing, along with the easing of COVID-19 related pressures saw the EBITDA margin recover to 9.5% at 1H FY21, indicating further strengthening through the year.
Despite no material increase to debt, reduced earnings and cash flows resulted in a deterioration in leverage metrics. Based on GCR’s calculations, net debt to EBITDA increased notably to 6.8x at FY20 (FY19: 2.2x). GCR notes management’s interventions, such as the dividend moratorium and capex deferrals to manage debt down. This, combined with the improved earnings is expected to see the net debt to EBITDA ratio reduce over the next 18-24 months, with the metric likely to trend between 3.8x – 4.7x at FY21. Interest coverage also deteriorated to 3.2x at FY20 (FY19: 7.8x), but the recovery to 4.6x in 1H FY21 affirms GCR’s expectations of a recovery into FY21 to around the 4x level.
To manage risk in light of the earnings pressures, Sappi proactively negotiated the suspension of its group covenants through to September 2021 (with the first subsequent measurement period being 31 December 2021). GCR views such actions as evidence of Sappi’s strong banking relationships and proactive treasury management, as well as its efforts to reset future covenant levels to incorporate sufficient headroom which have just been finalised.
Sappi’s liquidity is a supportive rating factor, with uses versus sources coverage ratios in excess of 2.0x on both a 12- and 24-month basis. The stronger performance in 1H FY21 saw an improved cash position of USD350m (FY20: USD279m), alongside USD660m in committed unutilised revolving funding lines. The group maintains strong access to international capital, which coupled with its proactive approach to refinancing, has enabled it to sustain a long-term debt maturity profile.
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 GCR’s expectations that the group’s robust liquidity profile will provide sufficient resilience to withstand pressures on pricing and demand. It also factors in an expected recovery in earnings through FY21.
Negative rating action could arise should there be a deterioration in the credit risk profile of the group as a result of 1) renewed pricing or demand shocks that result in reductions in margins and earnings; and 2) net debt to EBITDA remaining between 5x-6x post FY21.
Positive rating action could derive from 1) strong medium-term earnings growth, anchored by higher margin packaging and specialties’ products; 2) a reduction in debt such that net debt to EBITDA is sustained below 2x; 3) an adjustment to GCR’s country risk ranking could result in Sappi’s foreign operations and sales becoming relatively more important to overall corporate risk.
|Primary analyst||Eyal Shevel||Sector Head: Corporate & Public Sector Ratings|
|Johannesburg, ZA||Shevel@GCRratings.com||+27 11 784 1771|
|Secondary Analyst||Lara Krug||Senior Analyst: Corporate & Public Sector Ratings|
|Johannesburg, ZA||Larak@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, March 2021|
|GCR Corporate Sector Risk Scores, April 2021|
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||June 2020|
|Short Term Issuer||National||A1+(ZA)|
RISK SCORE SUMMARY
|Rating Factors and Sub-factors||Risk Scores|
|Country risk score||11.50|
|Sector risk score||5.50|
|Management and governance||0.00|
|Leverage and cash flow||(2.00)|
|Sappi Limited Total Risk Score||17.50|
|Essential subsidiary adjustment||(1.00)|
|Sappi Southern Africa Limited Total Risk Score||16.50|
|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 online 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 2020, and comparative historical audited financial statements;
- unaudited financial results for Sappi Limited for 1H 2021;
- audited financial results for Sappi Southern Africa Limited for 2020, and four years comparative financial statements;
- details of funding facilities; and
- group presentations.