Metso Outotec Outlook Revised To Negative On Increased Leverage Risk Due To COVID And Tie-Up; 'BBB-(Prelim)' Affirmed

  • n our view, the COVID-19 outbreak and lower demand for commodities could dent Metso Outotec's sales and profit margin prospects in 2020.
  • As a result, Metso Outotec may not be able to reach a level of adjusted funds from operations (FFO) to debt of at least 30% in 2020 unless management takes extraordinary measures or lowers shareholder returns to preserve its balance sheet.
  • We are therefore revising our outlook on Metso Outotec to negative from stable and affirming the preliminary 'BBB-' rating.
  • The outlook is negative because we believe we would downgrade Metso Outotec by one notch if its adjusted FFO to debt does not reach at least 30% by the end of 2020.
MILAN (S&P Global Ratings) March 25, 2020--S&P Global Ratings today took the rating actions listed above.
We revised the outlook to negative because of the risk that the COVID-19 outbreak, as well as lower commodity prices, could dent Metso Outotec's sales and profit margin prospects in 2020.   Metso Outotec may not be able to reach a level of adjusted FFO to debt of at least 30% in 2020 absent management taking extraordinary measures or lowering shareholder returns to preserve its balance sheet. We regard adjusted FFO to debt of 30% as the minimum leverage threshold for maintaining an investment-grade rating ('BBB-' or higher) on the Metso Outotec Group. Although we understand Metso Outotec's order intake for the first two months of 2020 has been largely unchanged against last year, we see emerging risks in the short- to medium-term, mainly owing to the severity and breadth of the spread of COVID-19, coupled with lower commodity prices that could affect demand for Metso Outotec's products. This comes on top of the risks that the merger of Metso Minerals and Outotec to form Metso Outotec already entails, including execution risks, the reliance on material synergies, aggressive dividend distributions, and Outotec's exposure to loss-making turnkey projects.
We understand the merger could be accomplished by mid-year 2020; therefore, we continue to expect some one-off costs to weigh on the operating performance this year and limit profit margin preservation.   Under our revised base case we see margins decreasing to about 10% in 2020 from 13.4% in 2019. However at this stage we have limited visibility on what type of countermeasures management is undertaking to preserve profitability. We continue to believe that the tie-up entails execution risks that could further add negative pressure to the group's profitability, if synergies do not materialize as expected, all else being equal. In addition, Metso Outotec's 2019 profitability is weaker than that of many of its investment-grade peers in the capital goods sector. Therefore, lack of clear margin improvement once the merger is complete, or continued material risks from its turnkey project activities, could lead us to revise down our current business risk assessment, which we already assess at the lower end of the range.
Metso Outotec's ability to deleverage will depend on its portfolio, dividend policy, and working capital management.  In 2019, the combined Metso Outotec group recorded negative free operating cash flow (FOCF), driven by working capital buildup at Metso Minerals. Metso Minerals' high working capital outlays, peaking at €224 million in 2019 and increasing from €111 million in 2018, owed partly to its recent McCloskey acquisition (October 2019), as well as some stocking issues. As a result, we estimate that Metso Outotec's combined pro forma FFO to debt remained at about 33% for 2019, which does not provide ample flexibility to face the challenges that COVID-19 and lower commodities prices are now posing. For 2020, we expect a potential working capital inflow of up to €80 million after the material buildup in 2019, which would sustain cash generation, lifting the FOCF to about €200 million from negative €15 million in 2019. Additionally Metso's dividend proposal on 2019 profits, which for Metso Group as a whole amounts to about €220 million, would put further pressure on credit metrics, if paid out as currently proposed.
We maintain the preliminary rating on Metso Outotec until the transaction closes.   We expect to finalize our rating on Metso Outotec once the transaction is complete. Therefore we expect to maintain the preliminary rating until that date. The final rating will depend on the company's successful transfer of €400 million notes to Metso Outotec, and the capital structure at closing (net debt, transfers from Neles to Metso Minerals, and debt refinancing). The final rating will also depend on our receipt and satisfactory review of all final transaction documentation. Accordingly, the preliminary rating should not be construed as evidence of the final rating. If S&P Global Ratings does not receive final documentation within a reasonable time frame, or if final documentation departs from materials reviewed, we reserve the right to withdraw or revise our ratings.
The outlook on Metso Outotec is negative because of the possibility we could downgrade the company over the following few months if the management's actions to address the COVID-19 pandemic and the expected lower demand are not enough to ensure adjusted FFO to debt of more than 30% at year-end 2020 for the newly combine group.
We could take a negative action on Metso Outotec if COVID-19 and lower expected commodities prices have a significantly negatively effect on its order book and sales, and consequently drive down its margins to below 11% with no prospects of improvement in the short term. Additionally, if the integration of Metso Minerals with Outotec proves more challenging than anticipated, it could negatively affect margins. Under this scenario FFO to debt would fall below 30%.
We could revise the outlook to stable if Metso Outotec proves able to maintain adjusted FFO to debt well above 30% and EBITDA margin consistently above 11%.
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