×

TEXT-S&P revises McJunkin Red Man Corp rating outlook

(The following statement was released by the rating agency)

Overview

-- Houston-based McJunkin Red Man Corp. is seeking to issue a $750 million term loan due 2019 and plans to use proceeds to refinance existing debt.

-- We are affirming our 'B+' corporate credit rating on McJunkin and assigning a 'B' issue-level rating to the new term loan with a recovery rating of '5'.

-- At the same time, we are revising our outlook on McJunkin to positive from stable because we anticipate that strong operating performance will continue, which we expect will result in leverage below 4x over the next 12 months.

Rating Action On Oct. 5, 2012, Standard & Poor's Rating Services revised its rating outlook on McJunkin Red Man Corp. to positive from stable and affirmed the 'B+' corporate credit rating on the company.

We also assigned our 'B' issue level rating (one notch lower than the corporate credit rating) to the company's proposed $750 million term loan due 2019. The recovery rating on the term loan is '5', indicating our expectation of modest (10% to 30%) recovery under our default scenario.

We expect McJunkin to use proceeds from the proposed term loan and availability on its asset-based loan (ABL) facility to repay its existing 9.5% senior secured notes due 2016. We anticipate we will withdraw our rating on McJunkin's existing notes when the company successfully completes the refinancing.

Rationale

The outlook revision follows our assessment that McJunkin's margin expansion and lower debt levels will likely result in stronger credit metrics that are more in line with a higher rating, given our view that energy sector demand for the company's pipes, valves, and fittings should remain relatively stable over the coming year. The company has improved its credit profile considerably this year by significantly reducing debt and improving operating leverage. The positive outlook also underscores our view that McJunkin will be able to sustain margins at current levels due to its realigned product mix and attentive inventory management.

We continue to assess McJunkin's business risk profile as "weak" and the financial risk profile as "aggressive." The business risk profile balances the company's large scale, scope, and diversity against its position in the highly fragmented, competitive distribution industry. The industry's business model characteristically exhibits low margins and requires high levels of inventory spending. We also note McJunkin's dependence on volatile energy-based end markets, which can cause earnings to fluctuate. The aggressive financial risk profile takes into account the company's lighter debt load and our "strong" liquidity assessment, but also considers its substantial working capital needs and that the company's private equity holders still retain a significant ownership stake following the public offering.

Our baseline scenario anticipates that demand for steel products from the domestic energy sector will remain relatively favorable over the next 12 to 18 months despite weaker prospects for the global steel industry overall as a result of oversupply pressures and slowing economic growth worldwide. We expect the company to generate annual revenues of more than $5.5 billion in 2012, touching every segment of the energy value chain, including the upstream, midstream, and downstream end markets. EBITDA margins are anticipated to grow just over 7% in 2012 as a better product mix and lower administrative expenses contribute to EBITDA levels above $400 million at year end. In 2013, we anticipate that revenues will remain relatively flat but that the company will continue to improve margins, albeit at a slower rate, with EBITDA in the range of $410 million to $430 million.

Our performance projections anticipate that positive overall demand in the company's energy-based end markets will support earnings growth, despite fluctuations within the upstream, midstream, and downstream industry sectors. McJunkin's strong, long-term customer relationships with major oil and gas companies also contribute to our expectations for improving earnings. These relationships provide comparatively stable maintenance, repair, and overhaul business and the opportunity for international growth, as McJunkin's recent agreement with Shell to expand its domestic valve distribution services internationally demonstrates. In addition, McJunkin has been repositioning its product mix to emphasize higher-margin valves, fittings, and flanges over tubular goods; reduced overhead spending; and refined working capital management since it was caught holding significant inventory during the financial crisis.

We anticipate that total debt, including adjustments for operating leases and pensions, will approximate $1.3 billion at year-end. We expect 2012 leverage below 3.5x and funds from operations (FFO)-to-total debt will be about 18%, compared with 5.8x and 11%, respectively, at the end of 2011. In 2013, we anticipate that the company will continue to focus on reducing leverage to around 3x and that lower interest costs from the proposed refinancing will result in FFO-to-debt above 20%. These metrics are good for the company's aggressive financial profile, which is constrained in part by the high level of private equity ownership and the company's acquisition-driven growth strategy.

McJunkin is a leading distributor of pipes, valves, and fittings, with about 90% of sales going to the North American energy industry. Demand for McJunkin's products fluctuates depending on energy prices, and the business is highly correlated with the strength of the overall economy. Additionally, as an industrial distributor, the company is vulnerable to price fluctuations in steel. The distribution industry model typically exhibits relatively slow inventory turnover, which can hurt profitability in periods of rapidly rising or falling prices. The company's ability to generate cash flow from working capital in a downturn somewhat offsets this.

Liquidity

We view McJunkin's liquidity as strong under our criteria. Our assessment is based on the following expectations:

-- Sources of liquidity are sufficient to cover uses by at least 1.5x over the next 12 months and by at least 1.0x over the next 24 months;

-- Liquidity sources will continue to exceed uses, even if EBITDA were to decline 30%;

-- Availability under the company's $1.25 billion ABL facility will not fall below $125 million or 10% of the aggregate facility commitments, which would trigger a minimum fixed-charge covenant; and

-- The company has no significant maturities until 2017.

As of June 30, 2012, McJunkin had total liquidity of $653 million, consisting of $40 million in cash and the remainder in availability under the company's $1.25 billion ABL due 2017. We expect McJunkin to maintain total liquidity, including cash and revolver availability, in excess of $400 million over the next 12 months.

We project that working capital needs will absorb significant amounts of cash as the company's performance improves and end demand grows, to the tune of about $100 million in 2012 and $80 million in 2013. McJunkin's business requires minimal capital expenditures, which we project will approximate about $20 million to $25 million annually for the next several years. McJunkin should generate free operating cash flow around $70 million in 2012, increasing to about $200 million in 2013 as one-time transaction expenses roll off and as the company benefits from lower required interest payments. Our analysis incorporates continued spending for small bolt-on acquisitions and our expectation that management will use excess cash to further reduce debt in lieu of shareholder rewards.

Following the transaction, McJunkin will have minimal maturities until 2017. The proposed term loan includes a 3.5x secured leverage covenant, with which we expect the company to remain in compliance on an ongoing basis. The ABL facility has a springing fixed charge covenant which is only applicable if availability falls below $125 million or 10% of the facility's total commitments.

Recovery analysis The rating on McJunkin Red Man's proposed $750 million term loan is 'B', one notch lower than the corporate credit rating. The recovery rating is a '5', indicating our expectation of modest (10% to 30%) recovery in the event of a payment default. For the complete recovery analysis on McJunkin Red Man, please see the recovery report to be published shortly on RatingsDirect.

Outlook

Our positive outlook for McJunkin reflects our assessment that lower debt and sustained margin increases may produce credit metrics which warrant a higher rating, with leverage between 3x and 4x and FFO-to-debt above 20%. Our outlook incorporates our expectation that the company will be able to withstand steel price fluctuations and some volatility with its end markets. We could raise the rating if McJunkin is able to sustain margins above 7% over the next 12 months and if the company had a higher proportion of public ownership.

We would lower the rating if McJunkin's leverage deteriorated and remained above 5x for a sustained period. This could occur if debt increased to pay shareholder rewards or finance an acquisition, if the company's margins contracted because of greater-than-expected steel price instability, or if decline in the company's end markets triggered a major slowdown in demand.

We could revise the outlook back to stable if McJunkin were unable to maintain expected margin levels or if it increased debt such that we expected leverage to be maintained between 4x and 5x.

Related Criteria And Research

-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Key Credit Factors: Methodology And Assumptions On Risks In The Metals Industry, June 22, 2009

-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009

-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed; Outlook Action

To From McJunkin Red Man Corp. Corporate Credit Rating B+/Positive/-- B+/Stable/-- New Rating McJunkin Red Man Corp. Senior Secured

US$750 mil term bank ln due 2019 B

Recovery Rating 5 Ratings Affirmed McJunkin Red Man Corp. Senior Secured B Recovery Rating 5

(Caryn Trokie, New York Ratings Unit)

((Caryn.Trokie@thomsonreuters.com; 646-223-6318; Reuters Messaging: rm://caryn.trokie.reuters.com@reuters.net))

Keywords: