Metso Corp. (Neles) Downgraded To 'BBB-/A-3'; Ratings Remain On CreditWatch Negative

  • Metso Corp.'s increased financial leverage--stemming from its recent acquisition of McCloskey for $300 million, poor working capital performance, and generous dividend distributions--is weighing on its consolidated financial performance, with funds from operations (FFO) to debt decreasing to about 40% in 2019 from above 80% at the end of 2018.
  • Negative pressure from the COVID-19 pandemic, lower commodity prices, and weaker market conditions will all likely weigh on Metso Corp.'s credit metrics in 2020, leading to an adjusted FFO-to-debt ratio of about 25% in our base case.
  • We are lowering our long- and short-term issuer credit ratings on Metso Corp. to 'BBB-/A-3' from 'BBB/A-2'. The issuer credit ratings remain on CreditWatch, where we placed them with negative implications on July 9, 2019.
  • The CreditWatch placement reflects the risk that we could downgrade Metso Corp. (to be renamed Neles) again once it demerges from its minerals division, Metso Minerals, and transfers it to Outotec (see "Metso Outotec Outlook Revised To Negative On Increased Leverage Risk Due To COVID And Tie-Up; 'BBB-(Prelim)' Affirmed," published March 25, 2020). This downgrade would ultimately depend on Neles' final capital structure following the spinoff.
MILAN (S&P Global Ratings) March 25, 2020-- S&P Global Ratings today took the rating actions listed above.
We think Metso Corp.'s credit metrics will be under pressure for 2020 due to the COVID-19 outbreak and lower commodity prices.   The downgrade primarily reflects the greater-than-expected weakening in Metso Corp.'s credit metrics. This stems from the recent acquisition of McCloskey for $300 million, as well as the proposed €220 million dividend on 2019 profits. Additionally, the recent significant oil price drop, downward trend of other commodity prices, and COVID-19 pandemic are all likely to exert pressure on the company's margins and topline. This could cause the company's S&P Global Ratings-adjusted FFO-to-debt ratio to decline to about 25% in 2020 from about 40% in 2019 and about 80% in 2018.
We expect Metso Corp. (to be renamed Neles) to have a comparatively weaker credit standing following the spinoff of Metso Minerals, so our issuer credit ratings on Metso Corp. remain on CreditWatch with negative implications.  Metso Corp.'s flow control segment (Neles) generated revenue of €660 million in 2019, which accounted for 18% of revenue and €104 million of earnings before interest, tax, and amortization. This is markedly lower than the €381 million generated by the minerals division. In addition, Neles will derive its full earnings and cash flow from the valves business, reducing its diversification.
The valves business will be more profitable, with margins at about 17% versus about 15% for Metso Corp. (consolidated for the full year 2019), due to the minerals division's lower profitability. However, we do not currently have clear visibility on Neles' financial risk profile, since it will depend on cash following the demerger, working capital needs, divided policy, future investment strategies, transaction costs, and potentially higher headquarters costs, among other developing factors. We therefore expect to assess Neles at the transaction's closing, when we will know the full details of its capital structure and strategies.
Given the very fluid and challenging environment generated by both the COVID-19 pandemic and lower commodity prices from 2020, we expect margins to drop by 300 basis points from 14.5% at end-2019.  The outbreak of COVID-19 has had a limited effect on Metso Corp.'s ordering intake and business activities in China. However, we anticipate a slowdown from the second quarter (Q2) of 2020. This will translate into organic growth falling by about 5%-10% from 2019 levels, excluding the recent McCloskey acquisition.
We also understand that the COVID-19 outbreak has not affected Metso Corp.'s operations or activities in China. However, we expect the increasing span of the pandemic to put pressure on margins and credit ratios.
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 "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now" and "COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure," published on March 17). As the situation evolves, we will update our assumptions and estimates accordingly.
We aim to resolve the CreditWatch placement when Metso Minerals spins off and merges into a new entity with Outotec, or when we have sufficient information to assess Neles' leverage, financial policies, operating stand-alone performance, and investment plans. We expect the merger of Metso Minerals with Outotec to occur by the end of Q2 2020.
At the deal's completion, we expect Neles' business to be materially weaker than that of Metso Corp. today. At this stage, given the size of the flow control division, as well as its limited business diversity at closing, we think a downgrade into the 'BB' category is likely.
We have downgraded Metso Corp.'s senior unsecured notes to 'BBB-' and removed them from CreditWatch. This reflects the successful closing of the bond solicitation process. On the date of the demerger, Metso Corp. will transfer the bonds to Metso Outotec, which has a preliminary 'BBB-' rating with a negative outlook.
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