Cabot Corp. Credit Rating Downgraded To 'BBB-' On Weakness In Auto Sector

  • We believe that a global macroeconomic slowdown in 2020, including continued weakness in the automotive market and a significant drop in oil prices, will lead to a further reduction in Cabot Corp.'s fiscal 2020 EBITDA and credit measures.
  • We are lowering our issuer-credit rating on the company to 'BBB-' from 'BBB'. We are also lowering our rating on the company's senior unsecured debt to 'BBB-' from 'BBB' and the short-term rating to 'A-3' from 'A-2'.
  • The stable outlook reflects our expectation that the ongoing recession and continued slowdown in the automotive sector will pressure fiscal 2020 EBITDA and credit measures, but we expect a recovery in fiscal 2021.
NEW YORK (S&P Global Ratings) March 24, 2020—S&P Global Ratings today took the rating actions listed above. The downgrade follows a significant downward revision in our macroeconomic expectations for 2020 because of the coronavirus pandemic. We expect a contraction in the U.S. and Europe, and materially slower growth in China, along with significantly weaker oil prices (which affect Cabot's selling prices). We have also significantly lowered our expectations for the automotive market and now project global sales will decline by about 15% in 2020 to less than 80 million units. As a result, we expect a moderate drop in 2020 EBITDA and credit measures, resulting in funds from operations (FFO) to debt dropping to, or modestly below, the 30% level we consider appropriate for the rating. Although we believe the depth and timing of the current recession will be less than the Great Recession of 2008-2009, the path of the coronavirus outbreak is very uncertain. If the virus is not contained, the macroeconomic impact could be much more severe than we're factoring in our 2020 assumptions. Cabot's current mix of businesses is different than it was in 2009, but it still depends heavily on the global tire and automotive markets. The 2009 global recession hurt Cabot's earnings and credit measures as fiscal 2009 revenues were down about 30%, with the majority of that driven by volume declines. However, a substantial release of Cabot's working capital in downturns somewhat offsets this. As a result, despite the meaningful volume reduction in 2009, Cabot generated record levels of free cash flow. Additionally, credit measures bounced back quickly and improved significantly in 2010.
The stable outlook reflects our expectation that fiscal 2020 EBITDA and credit measures will be pressured by the ongoing recession and continued slowdown in automotives, with a recovery in fiscal 2021. Our base case assumes that the impacts from the coronavirus pandemic will lead to a contraction in U.S. and Europe GDP in 2020, along with slower GDP growth in China than we had previously envisioned. We expect global light vehicle sales to fall by about 15% in 2020, with a recovery in 2021. In this uncertain operating environment, we believe the company will maintain financial policies that support the current rating, including scaling back on capital spending and share repurchases to preserve cash. At the current rating, we expect the company to maintain weighted-average FFO to debt of about 30%. In our base-case scenario, we expect fiscal 2020 FFO debt will drop to around or modestly below this level, although given our expectations for a subsequent global macroeconomic rebound and improved oil prices, would expect an improvement in this ratio starting in fiscal 2021.
We view a downgrade to speculative-grade as unlikely over the next two years. However, we could lower the ratings in the next two years if the current downturn in the global economy, and specifically the automotive markets, is significantly prolonged or much worse than we expect. In such a downside scenario, we believe that revenues could fall 5% and that EBITDA margins would need to drop by more than 400 basis points (bps) compared to our base-case expectations. In such a scenario, we would expect weighted average FFO to debt would drop sustainably to about 20%. We could also lower the ratings if the company does not scale back shareholder rewards and growth initiatives, particularly in a downturn.
We could consider an upgrade in the next two years if volumes and EBITDA are significantly higher than our base-case expectations, driven by stronger-than-expected GDP growth in key geographies and a recovery in demand in the automotive tire industry. Additionally, a rebound in oil prices could support improved product pricing. In such a scenario, we would expect the company to improve fiscal 2021 EBITDA margins by at least 200 bps compared to our fiscal 2020 forecast, along with moderately stronger revenue growth. For a higher rating, we would need to expect FFO to debt would sustainably improve and remain in the 30%-45% range, even after factoring in a potential future downturn.
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