Credit ratings agency Moody's has downgraded newsprint manufacturer Norske Skog’s rating from B2 to Caa1, a move the agency says affects about 1.3 billion Euros of rated debt.
A statement notifies the downgrade of the corporate family rating of the group, as well as the probability of default rating to Caa1 from B3. Concurrently, Moody's has also downgraded the rating for the group's outstanding bonds to Caa1. The outlook on the ratings remains negative.
"The downgrade of Norske Skog's CFR to Caa1 reflects the group's weak operational performance in Q2 2011 in combination with a muted fullyear outlook, which resulted in a downward revision of our full-year profitability and cash flow expectations," says Anke Rindermann, a Moody's assistant vice president and lead for Norske Skog.
“In addition, weaker operating profitability resulted in diminishing headroom under financial covenants governing the group's core 140 million Euros revolving credit facility. As covenant levels are tightening over time, this requires Norske Skog to continuously improve its net leverage position.
“A failure in achieving these improvements could restrict access to the facility and result in severe liquidity pressure already over the next few quarters.”
High input cost inflation as well as adverse currency movements and the effects of a fire at one of the group's major mills mitigated the benefits of significant price increases implemented earlier in the year. In addition, Moody's notes that price increases targeted by Norske Skog in its European business for Q3 2011 have been realised at levels clearly below previous indications.
Despite anticipating a strengthening of Norske Skog's profitability over the second half of 2011 compared to the first half due to seasonal effects as well as the Saugbrugs mill being fully operational again, Moody's says it would expect the group's net leverage ratio (as adjusted by Moody's) to be above 6.0x at the end of the current financial year. This is above Moody's previous expectation of close to 5.0x stated in a press release dated 30 May 2011. In addition, Moody's would expect Norske Skog's lower profit generation to negatively affect the group's cash flow generation, with free cash flow in 2011 likely to reach break-even to moderately negative levels only, though we note inflows related to asset disposals as well as to expected insurance proceeds.
As industry conditions remain challenging, the low levels of additional price increases realized despite continued high input costs also raises questions about the group's ability to materially improve its highly leveraged capital structure beyond 2011 despite targeted further internal cost saving measures as well as benefits from already implemented programmes.
More positively, Moody's recognises Norske Skog's progress over the past months in addressing upcoming debt maturities through asset disposals as well as refinancing actions. While this has resulted in a clearly improved maturity profile, we caution that tight covenant headroom requires further measures to safeguard the group's liquidity profile over the longer term, which however still need to be executed.
The negative outlook therefore mirrors the risk of a weakening liquidity profile if Norske Skog were unable to enhance profitability or secure additional disposal proceeds over the coming months given tightening covenant levels; or the group's free cash flow generation were to enter clearly negative territory.
In addition, the negative outlook reflects persistent challenges in the publication paper industry as a result of structural demand pressure, continued high input costs and low pricing power, which are preventing producers from achieving adequate returns.
Further negative pressure on the ratings could materialise if the group's liquidity profile were to deteriorate, especially if covenant headroom were to decrease significantly as a result of Norske Skog being unable to improve profit generation or if material amounts of negative free cash flows were incurred or Norske Skog were unsuccessful in restructuring its operations to bring relief to operating profitability and cash flow generation, says the statement.
“In view of today's rating action and the negative outlook, upward pressure is unlikely in the near term. The outlook could be stabilised if tight covenant headroom is addressed and/or if there were evidence of improving market conditions over the coming quarters and evidence of rising pricing power of manufacturer amid a tighter supply and demand balance in Europe, which would enable the group to clearly improve underlying operating profitability as well as evidence of a sustainable liquidity position.”