SGL Carbon Outlook Revised To Negative On Lower Expected Earnings And Management Changes; 'B-' Rating Affirmed

  • On Aug. 14, SGL Carbon announced that a planning assumption error in one division would lead to lower earnings versus original guidance. In addition, the company is experiencing softer market conditions.
  • The company's CEO has consequently resigned, which casts uncertainty on SGL's overall strategy and ability to meet its medium- and long-term objectives.
  • We are therefore revising our outlook on SGL to negative from stable, and affirming the 'B-' long-term issuer credit rating.
  • The negative outlook reflects the uncertainty over the company's ability to recover its operations and financial performance in the coming 12-18 months.
PARIS (S&P Global Ratings) Sept. 3, 2019--S&P Global Ratings today took the rating actions listed above. We revised our outlook on SGL to negative because of the weaker expected results following the announcement regarding erroneous planning assumption in its carbon fiber materials (CFM) division and the sudden departure of its CEO, which casts uncertainty over the strategic direction and ability to meet its objectives. The negative developments come on the back of already deteriorating market conditions across some of the company's end markets.
Our current rating is nevertheless still supported by SGL's leading position in its niche markets and their positive fundamentals, as well as the company's fair ability to manage its debt level and its free operating cash flow (FOCF) through flexibility of its capital spending (capex) and potential further improvement in working capital in the coming years. However, the headroom under the rating is very tight.
We expect the company to report weaker credit metrics and additional negative FOCF, further delaying its ability to meet some of its financial objectives. Under our revised base-case scenario, we project adjusted EBITDA of about €100 million in 2019 (versus the previous assumption of €135 million-€145 million) and €100 million-€110 million in 2020. We also project negative FOCF of about €40 million-€50 million in the 18 months ending Dec. 31, 2020.
We believe that the recent announcement on erroneous planning assumptions signals potential weakness in internal controls. Combined with SGL's mixed track record of meeting some of its financial policy and planning objectives, and the unexpected departure of the CEO, it has led us to change our assessment of the company's management and governance to weak from fair.
On Aug. 4, the company discovered that some of its underlying cost assumptions in certain contracts in the CFM division related to the wind business were much higher than they should have been, resulting in the contracts being less profitable. We understand that this error, combined with tougher market conditions than originally anticipated, will have an about €15 million effect on 2019 EBITDA. Furthermore, the company had assumed that new contracts would have similar and improving profitability in 2020 and thereafter, which is no longer the case. As a result, the company has suspended its public guidance for this division.
The company's CEO, Juergen Koehler, resigned along with the CFM division announcement. Mr. Koehler had been SGL's CEO since January 2014, and had led the restructuring of SGL's business. He also was the acting CEO of the CFM division, after the departure of the previous CEO in May 2019. No other personnel changes were announced, and the company's board has reiterated its commitment to the company.
In our view, the medium- and long-term fundamentals of the company's core product applications--energy, mobility, and digitalization--remain strong, and should support the growth of results and underlying earnings. Moreover, the company remains committed to expanding its automotive, LED, and semiconductor businesses. In this respect, we see the hiccup in the company's credit metrics as temporary, and we think they should normalize under slightly better market conditions and lower capex needs.
The negative outlook reflects the uncertainty over SGL's ability to recover its operations and financial performance in the coming 12-18 months. Recovery could prove more challenging if market conditions continue to deteriorate and SGL does not establish effective leadership and a clear strategy.
In our base case, we forecast adjusted debt to EBITDA of about 6x in 2019 and in 2020, above the 4x-5x range commensurate with the existing rating. We believe SGL will be able to improve its credit metrics in 2021 after the completion of its growth capex underway and general growth in its core markets. In addition, we forecast negative FOCF of more than €50 million in the next two years.
Our rating doesn't factor in other material organizational changes, including revision in the company's strategy, major restructuring plans, or departure of additional key personnel.
We could lower the rating if we classified SGL's capital structure as unsustainable. This would be the case if we revised downward our base-case for 2020 and thereafter. We believe that adjusted debt to EBITDA at 6.0x-6.5x in 2020, without any prospect of rapid further improvement to 5.0x and and neutral FOCF would lead to a negative rating action. Such a scenario is likely if SGL experiences a continued sharp collapse in demand for its products, and less meaningful contribution from some of its ongoing initiatives.
A revision of the outlook to stable would rest on the company's ability to maintain its leverage below 5x and to generate neutral or positive FOCF.
This would be further supported by clarity as to the long-term strategy and a track record of predictability in EBITDA and FOCF generation, especially in the CFM division.
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