(The following statement was released by the rating agency)
-- Specialty chemical producer PQ Corp. plans to redesignate as restricted subsidiaries, Potters Holdings II L.P. and its subsidiaries. As a result, we view the combined group as a single credit entity. The Carlyle Group will retain majority ownership at PQ Corp following the combination.
-- PQ Corp. plans to refinance all debt at PQ and Potters using proceeds from proposed debt issuance.
-- We revised the outlook to stable from negative because we expect the transaction will reduce refinancing risks and modestly improve liquidity, though we still view the company as having a highly leveraged financial risk profile.
-- We are affirming our 'B' corporate credit rating on PQ and assigning issue and recovery ratings to proposed debt issues.
Rating Action On Oct. 11, 2012, Standard & Poor's Ratings Services revised its outlook on PQ Corp. to stable from negative. We also affirmed our 'B' corporate credit rating and assigned our 'B+' issue ratings and '2' recovery ratings to the company's proposed first-lien senior secured credit facilities consisting of a $150 million revolving credit facility and a $1.1 billion term loan. The '2' recovery rating indicates our expectation for substantial recovery (70%-90%) in the event of a payment default. In addition, we assigned our 'B-' issue rating and '5' recovery rating to the proposed $720 million in second-lien notes. The '5' recovery rating indicates our expectation for modest recovery (10%-30%) in the event of a payment default. All ratings reflect preliminary terms and conditions. We will withdraw our ratings on Potters and on existing debt at PQ following the successful completion of the proposed transaction.
The outlook revision to stable from negative reflects our expectation that the debt refinancing will reduce PQ's refinancing risk by extending maturities, including 2014 maturities of about $1 billion in debt. The outlook revision is also underpinned by our expectation that credit measures at the combined entity have stabilized and will gradually improve. Liquidity also improves modestly because of a proposed new $150 million revolving credit facility. PQ Corp. currently does not have a revolving credit facility. In addition, we expect that the combination with Potters, which generates lower proportionate revenue relative to standalone PQ from currently weak European markets, reduces slightly credit risk related to PQ's higher dependence on these markets. Key credit risks include a highly leveraged financial profile, ongoing exposure to weak markets in Europe albeit at a lower level, and the absence of any cushion at the current ratings for even temporary declines in earnings that could increase leverage.
Our ratings on Malvern Pa.-based PQ Corp. reflect the company's "highly leveraged" financial profile, including very aggressive financial policies and its "fair" business risk profile. PQ is a specialty chemical producer that manufactures and markets inorganic specialty chemicals and specialty catalysts. The company produces sodium silicate, magnesium sulfate, zeolites, polyolefin catalysts, and other industrial chemicals. Following the combination with its 100% owned subsidiary Potters Holdings II L.P., PQ will also be a maker of glass beads for various industrial applications. The combination follows the 2011 separation, by designation as unrestricted subsidiaries, of the Potters business from PQ, which caused us to view support to PQ from Potter's operations as very limited. Potters is much smaller in revenue terms relative to PQ.
PQ Corp.'s highly leveraged financial profile and ownership constrain its ratings. The Carlyle Group is the majority owner of PQ, with financial policies that we characterize as very aggressive. We expect very thin cash flow generation, if any, in future years, and do not expect the company to meaningfully reduce its debt levels. Nonetheless, our ratings assume that management will not pursue financial policies, including growth plans or any acquisitions that further stretch the highly leveraged financial risk profile. We expect modest improvements in EBITDA will lead to a gradually improving financial profile with leverage credit metrics strengthening steadily over the next several years to levels consistent with our expectations at the rating. At the current ratings, we expect the key ratio of funds from operations-to-total debt to approach 10%. We expect the ratio to be about 5% pro forma for the combination and related financing. We anticipate that the consolidated ratio of adjusted debt-to-EBITDA will be high at about 7x on a pro forma basis, higher than our expectations at the rating for this ratio to approach 6x.
PQ's business risk profile remains "fair" on a combined basis. The business is characterized by well-established market positions, geographic diversity, a largely inorganic raw material base, and high operating margins. The company has a number 1 or number 2 market position in almost its entire product line. In sodium silicate, the company's single-largest product category by sales, PQ holds a major portion of the North American market and a strong position in the European market. Significant geographic diversity further supports the fair business profile, though in recent times, the company's exposure to European markets beset by weak economic growth has emerged as a credit risk. PQ operates many strategically located production sites globally, which provide diversity and an advantage versus its smaller and more narrowly focused competitors. Sodium silicate solutions are expensive to transport, and competitive production necessitates a large manufacturing base. However, operations are somewhat energy intensive and subject to volatile pricing in soda ash--a key raw material for the company. Nonetheless, the raw material base for the business is relatively broad and mostly inorganic, which limits exposure to volatility in petrochemical feedstock costs.
EBITDA margins are high and expected to remain in the 23% to 25% range, reflecting the combined businesses market leadership position, and other business strengths. While margins have remained relatively stable in recent years, we expect weak operating environment in key markets to stymie revenue and EBITDA growth, despite the company's business risk profile strengths. This expectation results in our assumption of relatively flat EBITDA levels in 2012, and only modest improvements in 2013 and beyond. Other assumptions related to EBITDA include:
-- The company will continue to pass through any input or manufacturing cost increases to customers. However, the weak operating environment will constrain pricing preventing any near-term improvement in margin levels.
-- There is potential for growth in EBITDA in relatively small, but high value added, niche businesses, such as the catalyst business, but we do not expect the overall impact on company EBITDA to be meaningful over the next 12 months.
We believe PQ will maintain "adequate" liquidity (under our criteria). We expect sources of funds, consisting primarily of cash on the balance sheet and availability under a new revolving credit facility, to exceed uses by at least 1.2x over the next year. The new credit facility is an additional future source of liquidity that the company does not currently have. PQ replaced its former facility with a term loan earlier in 2012. We do not expect the company to generate free cash flow on a consistent basis, given the meaningful outflows on capital spending program and interest, and our expectation that working capital usage is unlikely to decline and release cash flow. However, free operating cash flow should not be significantly negative. We believe net sources would be positive even with a 15%-20% drop in EBITDA.
We base our conclusions on liquidity on the following assumptions:
-- Through the proposed refinancing the company is successful in refinancing its debt including large maturities of about $1 billion in 2014, and in establishing a new revolving credit facility as envisaged.
-- We expect the company will be prudent in its capital spending plans, a meaningful portion of which we view as discretionary.
-- There will be no shareholder rewards over the next one-two years.
-- The company is able to maintain sufficient cushions under proposed new covenants under its planned credit facility, and covenant compliance would also withstand a 15% to 20% drop in EBITDA.
Recovery analysis We assigned our 'B+' issue ratings and '2' recovery ratings to the company's proposed first-lien senior secured credit facilities consisting of a $150 million revolving credit facility and a $1.1 billion term loan. The '2' recovery rating indicates our expectation for substantial recovery (70%-90%) in the event of a payment default. In addition, we are assigning our 'B-' issue rating and '5' recovery rating to proposed $720 million in second lien notes. The '5' recovery rating indicates our expectation for modest recovery (10%-30%) in the event of a payment default. For the complete recovery analysis, see, "PQ Corp.'s Recovery Rating Profile," to be published shortly following this report on RatingsDirect.
The stable outlook reflects our anticipation of modest improvements to liquidity and to the debt maturity profile resulting from the transaction, and expected stabilizing of credit metrics. Additionally, the combination with Potters diminishes somewhat, but does not eliminate, our view of the income risks and cash flow volatility arising out of the exposure to challenging European markets over the next 12 months. Still, we believe that the company has little cushion for any unexpected setbacks to earnings or cash flow given the high levels of debt leverage. Leverage credit metrics are weak relative to our expectation at the rating. We believe there will be a very gradual strengthening in these metrics arising out of gradual improvements in earnings.
We could lower ratings if this anticipated strengthening does not materialize or if earnings or liquidity weaken so that leverage credit metrics deteriorate from current levels. This could happen if revenue growth stalls or turns negative, or if EBITDA margins decline by more than two percentage points from current levels. We could lower ratings if the combination and related financing does not take place, which would likely, heighten credit risks, including refinancing risk, as we approach the 2014 maturity date for about $1 billion in PQ debt.
The company's highly leverage financial risk profile constrain the ratings. We would raise the ratings if the financial risk profile improved due to greater earnings growth than we expected, or if the company paid down meaningful levels of debt, though we currently do not believe PQ will generate sufficient cash flow to do so. We could also upgrade the company if the ratio of funds from operations-to-total debt exceeded 12% on a sustainable basis.
Related Criteria And Research
-- General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Key Credit Factors: Business And Financial Risks In The Commodity And Specialty Chemical Industry, Nov. 20, 2008
Ratings Affirmed; Outlook Action
To From PQ Corp. Corporate credit rating B/Stable/-- B/Negative/-- New Rating PQ Corp. Senior secured
US$150 mil revolving credit fac B+
bank ln due 2017 Recovery rating 2
US$720 mil second-lien nts due
Dec. 2018 B- Recovery rating 5
US$1.1 bil first-lien term bank ln
due 2017 B+ Recovery rating 2
(Caryn Trokie, New York Ratings Unit)