Equipment Rental Provider Ashtead Group PLC Outlook Revised To Negative On COVID-19 Uncertainty; 'BBB-' Rating Affirmed

We think U.S. demand for Ashtead's equipment will materially decline due to the spread of COVID-19, with sales declining by up to £500 million and EBITDA margins reducing by 300 basis points in the financial year ending April 30, 2021 (FY2021) from an estimated 47.5% in FY2020.
We note that the speed at which Ashtead is able to reduce capital expenditure (capex), halt mergers and acquisitions (M&A), and preserve cash is key to weathering the economic uncertainty that the COVID-19 pandemic is causing.
We are revising our outlook on Ashtead to negative from stable and affirming our 'BBB-' issuer credit rating on the group.
The negative outlook reflects our view that we could lower the ratings on Ashtead over the next few months if the COVID-19 pandemic results in a larger-than-expected spike in the group's S&P Global Ratings-adjusted debt to more than 3.0x and FFO to debt weakening to less than 30%, without any prospect of a swift recovery.
LONDON (S&P Global Ratings) March 26, 2020--S&P Global Ratings today took the rating actions listed above.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak between June and August, and we are using this assumption in assessing the economic and credit implications. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
The effect of the COVID-19 pandemic on Ashtead's U.S. customer base could materially harm the group's financial results--at least in the short term--putting pressure on the group's credit quality.   Ashtead generates more than 90% of its revenue in the U.S., with some operations in Canada and the U.K. In the third quarter (Q3) FY2020, Ashtead's fleet utilization rates were about 50% (53% last 12 months [LTM] U.S; 48% LTM Canada; 46% LTM U.K). We expect this utilization to fall materially in the next few weeks after governments imposed restrictions that will likely result in Ashtead's customers completely closing their work sites. As a result, revenue from rental equipment will be materially down until the pandemic abates. We note that in previous economic downturns, Ashtead was able to react quickly to a sudden drop in demand by limiting capex and M&A spend.
However, in reaction to the spread of COVID-19, particularly in Europe, governments have been locking down entire cities or countries. Rental equipment providers are therefore experiencing a sudden and complete drop in revenue and cash flows across the entirety of their customer bases. We think the U.S. authorities could take a similar approach, meaning the effect on Ashtead could potentially be more severe than during the last financial crisis.
We think Ashtead could reduce costs but we still estimate fixed costs of about £600 million per year. Pressure on profitability could lead to a spike in adjusted debt to EBITDA of about 2.5x-3.0x and FFO to debt of 32%-34% in 2020. We then expect a recovery and subsequent leverage reduction, which would bring weighted average credit metrics back in line with the current rating level. If the pandemic or government-imposed lockdowns last longer than expected or the recovery is not as immediate as we envisage, rating pressure could increase.
Ashtead's ability to rapidly reduce investment to preserve its liquidity and credit metrics will be crucial to weathering the pandemic.   We expect Ashtead will protect cash and cut costs as much as possible during the period of subdued demand. This includes an immediate and material reduction in gross capex to about £500 million-£600 million for FY2021--Ashtead was previously guiding to £1,110 million–£1,290 million gross fleet expenditure. We also expect Ashtead to postpone all new M&A activity--about £400 million-£500 million per year--and tighten its working capital. We also expect Ashtead to cancel all share buybacks--£125 million per quarter--and likely postpone any future discretionary cash flows. As a result of these measures, we think Ashtead could reduce its cash spend by £1.0 billion-£1.3 billion in FY2021.
As of Q3 FY2020, Ashtead had £20 million unrestricted cash on balance and £1,097 million of headroom under its $4.1 billion committed asset-backed revolving credit facility (RCF). We think this should be sufficient to cover the group's minimum operating cash expenditure coming up in the coming months, including debt interest, and assuming the group cuts costs. The group has no material debt maturities before 2023.
There is a fixed charge coverage covenant in the capital structure that applies when the group has less than $410 million availability under the asset-backed loan. The covenant is set at 1.0x. We do not expect Ashtead to breach this covenant in the next six months.
The negative outlook reflects our view that we could lower the ratings on Ashtead over the following few months if the COVID-19 pandemic results in a larger-than-expected spike of adjusted debt to more than 3.0x without any prospect of a swift recovery.
It also reflects our view that Ashtead's liquidity position could come under pressure if the group does not react quickly enough to reduce costs and investments.
We could lower the rating in the next few months if Ashtead exhibits debt to EBITDA above 3.0x or FFO to debt of less than 30% on a sustained basis, with no prospect of a swift recovery.
We could revise the outlook to stable if utilization rates recover strongly in the second half of 2020, such that the group looks set to recover profitability, leverage, and free operating cash flow (FOCF) broadly to FY2020 levels.
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