Johannesburg, 22 November 2019 – GCR Ratings (“GCR”) has revised the long term Issuer rating of Sappi Southern Africa Limited to AA(ZA), based on a change in Criteria. Concurrently, GCR has affirmed Sappi Southern Africa Limited’s short term Issuer rating of A1+(ZA). The Outlook is Stable.
|Rated Entity / Issue||Rating class||Rating scale||Rating||Outlook / Watch|
|Sappi Southern Africa Limited||Issuer Long Term||National||AA(ZA)||Stable Outlook|
|Issuer Short Term||National||A1+(ZA)|
On May 22, 2019, GCR announced that it had released a new rating framework and sectoral criteria. As a result, the ratings of Sappi Southern Africa Limited (“SSA”, or “the company”) were placed “Under Criteria Observation”. Subsequently, GCR has finalised the SSA rating review under the new Criteria for Rating Corporate Entities. As a result, the ratings have been removed from ‘Under Criteria Observation’.
In GCR’s opinion, SSA is an essential operating entity of Sappi Limited (“Sappi”, or “the group”). This reflects the 100% ownership, operational integration, as well as a history of strong performance. GCR specifically notes SSA’s key contribution to group EBITDA (FY19: 49%; FY18: 44%), as well as the strategic capacity that further entrenches the group’s competitive position.
Accordingly, SSA’s ratings are underpinned by the group’s robust competitive position globally, strong access to capital, and sound liquidity. Counterbalancing these strengths is the susceptibility of SSA and the group to the inherent cyclicality in the paper and pulp industry, earnings variability, and the group’s moderate levels of leverage.
Sappi’s competitive strengths are anchored in its extensive global capacity, with low-cost plants in Europe, North America and South Africa. Operational integration, strong supplier relationships and procurement efficiencies also mitigate the impact of currency risk and price volatility on the group margin. Cognisance has been taken of the global reach of Sappi’s product range, although the group remains susceptible to earnings volatility due to global pricing dynamics in the pulp market, and the structural decline of legacy paper products.
In this regard, and notwithstanding the sound FY19 performance, FY20 margins are expected to be especially curtailed by subdued dissolving wood pulp prices, which remain close to historical lows. Constrained demand along certain paper product lines is also expected to place pressure on European margins. Overall, GCR expects market dynamics to place considerable pressure on SSA’s cash generation in FY20, albeit the impact on group operating cash flows will be partially counterbalanced by efficiency enhancements and rigour in the working capital cycle. As the underlying demand for the sustainable product ranges remains sound, earnings beyond FY20 are expected to benefit from additional capacity from the Saiccor expansion in South Africa, further diversification across targeted packaging product lines (supported by increased versatility of capacity), as well as pulp integration between the US and Canadian plants.
With respect to leverage, the group continues to target net debt to EBITDA of 2.0x, and to this end, has committed to a dividend moratorium. Sappi has also cut back its capital commitments from USD674m at FY18, to USD460m, with no material commitments beyond FY20, to stabilise its financial profile through the current pricing downcycle. As such, while GCR expects leverage to spike above the 2.5x threshold at FY20, the prudence in financial policy is positively considered. This is expected to see the group sustain sound headroom on its temporarily revised debt to EBITDA covenant of 4.5x (from 3.75x previously), after taking account of an additional USD180m in debt related to Matane and the potential for reduced cash generation from SSA in FY20. Group interest coverage is expected to trend within the 5.0x to 10x range over the rating horizon, representing reasonable headroom on a covenant of 2.5x. Sappi’s relatively low and variable cash flow coverage of gross debt remains the weakest leverage factor, with discretionary coverage expected to continue to trend below 20% over the rating horizon.
While no longer net ungeared, SSA continues to present a more conservative leverage profile compared to the group, with debt to EBITDA expected to continue to trend below 1.5x despite the pressure on earnings and the outlay for expansionary capex earmarked for FY20. GCR still expects comfortable headroom to be sustained on the debt to equity and debt service covenants of 65% and 2.0x respectively. However, the historically robust operating and discretionary cash flow coverage of gross debt is expected to come under pressure in FY20, due to the likely increase in debt, as SSA still has to fund a sizeable capital commitment until additional Saiccor capacity is commissioned and bedded down.
Group liquidity is considered to be a positive ratings factor. At FY19, liquidity was anchored by USD640m in unutilised, committed revolving facilities (SSA: R1bn), as well as USD393m in cash across the key territories, with a relatively competitive cost of funding including interest hedges. The early refinancing of the 2022 notes also demonstrates conservatism in the treasury function, in GCR’s opinion. Although the Matane transaction represents a sizeable outlay at a time when group earnings are under pressure, liquidity coverage is expected to remain sound, falling within the 1.5x to 1.8x range over 12 months. In comparison, SSA’s liquidity is constrained by maturing obligations in respect of medium-term notes and its GroCapital facility, although GCR has considered advanced plans to refinance these obligations. Cognisance has also been taken of the group’s strong access to capital, demonstrated by the range of banking counterparties and sustained appetite for its European and South African debt issues.
The Stable Outlook reflects expectations that the group’s financial profile should withstand the potential for weaker year-on-year cash generation in SSA amidst weaker paper and pulp prices.
All else being equal, a protracted deterioration in the group credit risk profile could result in a downgrade of SSA’s ratings. Sustained margin pressure that curtails SSA’s liquidity below expectations could also result in negative rating action. Positive rating action is not considered likely until ongoing capital project(s) are completed and fully bedded down in the intermediate term.
|Primary analyst||Patricia Zvarayi||Deputy Sector Head: Corporate Ratings|
|Johannesburg, ZA||patricia@GCRratings.com||+27 11 784 1771|
|Committee chair||Eyal Shevel||Sector Head: Corporate Ratings|
|Johannesburg, ZA||shevel@GCRratings.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 Ratings Scale, Symbols & Definitions, May 2019|
|GCR Country Risk Scores, June 2019|
|GCR Corporate Sector Risk Scores, updated November 2019|
Sappi Southern Africa Limited
|Rating class||Review||Rating scale||Rating class||Outlook||Date|
|Issuer Long Term||Initial||National||A(ZA)||Stable||Nov 2015|
|Issuer Short Term||National||A1(ZA)|
|Issuer Long Term||Last||National||AA-(ZA)||Stable||Mar 2019|
|Issuer Short Term||National||A1+(ZA)|
RISK SCORE SUMMARY
|Country risk score||12.00|
|Sector risk score||5.50|
|Management and governance||0.00|
|Leverage and capital structure||-1.50|
|Sappi Limited Total Risk Score||18.00|
|Essential subsidiary adjustment||-1.00|
|Sappi Southern Africa Limited Risk Score||17.00|
|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.|
|Risk Management||The process of identifying and monitoring business risks in a manner that offers a risk/return relationship that is acceptable to an entity’s operating philosophy.|
|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; 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 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:
- reviewed financial results for Sappi Limited for 2019, and comparative historical audited financial statements;
- audited financial results for Sappi Southern Africa Limited for 2018, and five years comparative financial statements;
- details of funding facilities; and
- medium term financial projections.