Specialty Chemicals Producer Atotech Downgraded To 'B-' On COVID-19 Disruptions; Outlook Stable

  • Although Atotech U.K. Topco Ltd. has yet to quantify the potential impact of the COVID-19 pandemic for 2020 as the outbreak continues to evolve, we anticipate that supply chain issues, combined with reduced demand for electronics and light vehicles globally, will take a toll on the company's leverage.
  • We now forecast that Atotech's S&P Global Ratings-adjusted EBITDA will decline to $315 million in 2020 from $331 million in 2019, causing adjusted leverage to rise above 7.0x; previously, we forecast a ratio of 6.0x-7.0x.
  • As a result, we are lowering to 'B-' our issuer credit rating on Atotech, and downgrading its related debt instruments by one notch.
  • The stable outlook indicates that Atotech is still likely to generate positive free operating cash flow (FOCF) and retain adequate liquidity and headroom under financial covenants. These factors reduce the risk of further credit deterioration.
LONDON (S&P Global Ratings) March 25, 2020-- S&P Global Ratings today took the rating actions listed above.

Recent disruption to its manufacturing in China and the long-term effect of the pandemic on demand will put Atotech under pressure in 2020

Atotech recently indicated that its performance in the first quarter of 2020 will be relatively close to first quarter 2019 levels. Its production facilities in China are now fully operational and ramping up--the situation appears to be stabilizing in much of China. That said, we believe Atotech is at risk not only through its operations, but also through its sales. In the short term, Atotech's products could suffer supply chain disruptions in China; in the longer term, we expect to see a protracted period of lower demand extending globally across all Atotech's geographies and end-markets.
We anticipate that Atotech will feel the effects of the disruption arising from the COVID-19 pandemic from the first quarter of 2020. It has direct exposure to China, which accounted for about 38% of its chemistry division in 2019, the largest by revenue. We now expect China's economy to shrink by 10% during the first quarter, compared with the same period a year ago (see "Economic Research: Asia-Pacific Recession Guaranteed," March 17, 2020). Our real GDP growth expectations for China in 2020 have also shrunk to 2.9% from 4.8% previously.
The outbreak in China has now morphed into a full-blown global pandemic. Asia Pacific alone, the first region affected, accounts for a further 33% of Atotech's chemistry revenue. S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak in particular countries and regions. That said, our base case assumes a reduction in global GDP of 0.5 percentage points (ppt) to 1.0%-1.5% this year. We also revised down GDP growth in the eurozone and the U.S: two of the main areas where Atotech's end-customers operate. Our forecast for the eurozone is down by 0.5 ppt, and for the U.S. is down 0.3 ppt (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now," March 17, 2020). Downside risks to our base-case forecast could arise, depending on whether the epidemic persists beyond the second quarter of 2020.

Atotech's revenue and EBITDA growth in 2020 are particularly at risk, given its large exposure to the automotive sector.

We anticipate the outbreak will cause already-weak demand to worsen and lower volumes in the automotives sector, which accounted for about 36% of chemistry revenue in 2019. The general metal finishing (GMF) segment, which supplies chemical equipment that has a wide range of applications in the automotive sector, was already down 6% organically in 2019. Despite evidence that China is starting to see some recovery from COVID-19, we think it is likely that light vehicle sales in China will decline by 8%-10% this year because of the first-quarter shock.
Globally, the situation is worse. We are further lowering our forecasts for global light vehicle sales as the COVID-19 pandemic escalates and global growth heads sharply lower. We now project global sales will decline by almost 15% in 2020 to less than 80 million units (see "COVID-19 Will Batter Global Auto Sales And Credit Quality," March 23, 2020).

During the first half of 2020, Atotech is likely to suffer a significant volume decline in electronics

Electronics represented 40% of Atotech's chemistry revenue in 2019. The COVID-19 outbreak in China has led to severe restrictions disrupting the global technology sector, especially hardware and semiconductor companies.
We estimate that China accounts for more than 70% of global phone manufacturing and the gradual recovery of its supply chain across logistics, transportation, and millions of laborers will weigh on the timing of new phone launches. That said, we don't expect phone-related supply chain issues to reverberate beyond the first half of the year.
Many of the hardware and smartphone manufacturers to which Atotech supplies electronic plating chemicals and equipment still assume that demand will be deferred by a quarter or two, and that recovery in the second half of the year may make up for the first-half loss. We agree that the second half will see a recovery, but believe some demand, especially in hardware, will be permanently lost as enterprises, IT service providers, and consumers lose confidence in the economy. This will cause them to reduce orders for later quarters ("Global IT Spending Set To Slide As Coronavirus Hits Hardware Sales," March 19, 2020).
The COVID-19 outbreak has decimated smartphone demand in China, where International Data Corp. (IDC) has forecast a decline in phone consumption of about 40% during the first quarter of 2020. IDC does not expect growth to return until the third quarter. China accounted for approximately 30% of smartphone consumption in 2019. Although we see signs of the outbreak in China stabilizing, U.S. and Europe are in the early stages of demand destruction as economic activity comes to an indefinite halt and consumer confidence wanes.

Although adjusted debt is now forecast to exceed 7.0x in 2020, FOCF will remain positive and liquidity adequate

This could reduce further deterioration in credit metrics. Our preliminary forecast suggests that adjusted EBITDA could decline to about $315 million in 2020 from $331 million in 2019. This scenario would arise if revenue fell by 2% and the adjusted EBITDA margin by 100-200 basis points (bps) to 26%-27%. This would mean adjusted debt to EBITDA increasing to about 7.5x in 2020, from below the 6.5x that we initially estimated for 2020.
If the outbreak proves more difficult to contain, the effects on Atotech could be more extensive than we currently forecast--lengthy factory shutdowns or significant underutilization could materially lower the global output of components, subassemblies, or finished goods.
Currently, we anticipate that the company will maintain positive FOCF of $50 million in 2020 (initial forecast: above $100 million). Although FOCF to debt is now around 3%-5%, we consider that Atotech's continued ability to generate positive cash flow could prevent its creditworthiness from deteriorating further.
We anticipate that Atotech will maintain adequate liquidity in 2020, supported by a multicurrency committed senior secured revolving credit facility (RCF) that had borrowing capacity of about $230 million as of December 2019 and is available until 2022.
The stable outlook indicates that we expect Atotech to generate positive FOCF even as its adjusted debt to EBITDA increases to about 7.5x in 2020. Additionally, we consider that its liquidity and headroom under financial covenants will remain adequate. Both of these factors reduce the risk of further credit deterioration.
We could lower the rating if Atotech's operating performance deteriorates to such an extent that FOCF turns negative, or if its interest coverage ratio falls below 2.5x and we think its credit metrics are likely to deteriorate significantly in 2021. We could also lower the rating if the company's liquidity deteriorates materially.
These scenarios could result from a steeper decline in revenue and EBITDA than we currently anticipate.

We could raise the rating if revenue in electronics and automotive segments recovers in the second half of 2020 and looks set to grow in 2021. We consider that these conditions would lead to a strengthening in EBITDA, enabling the ratio of adjusted debt to EBITDA to return comfortably below 7x on a sustainable basis.
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