Fitch Assigns Initial 'B' IDR to HP Pelzer; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an initial Issuer Default Rating (IDR) of 'B' to HP Pelzer Holding GmbH (Pelzer). In addition, Fitch has assigned a rating of 'BB/RR1' to Pelzer's proposed EUR230 million senior secured notes. The Rating Outlook for Pelzer is Stable.

KEY RATING DRIVERS

Pelzer's ratings are supported by its relatively strong position in the global automotive acoustical materials market and its diversified roster of global automotive customers. The company's credit profile is characterized by moderate leverage but low operating margins and weak free cash flow. Pelzer's organizational structure has been in a period of transition in the time since Adler Group S.p.A. (Adler) first took a stake in the company in 2010. After taking full control of the company in 2013, Adler has begun the process to merge Adler's existing automotive businesses with those of Pelzer. Fitch expects these changes to strengthen Pelzer's operating profile, further increasing its global scale and the breadth of its product offerings. As the company begins to achieve benefits from this transition, Fitch expects Pelzer's profitability and cash flow generation to improve markedly.

Fitch's concerns include Pelzer's relatively small size, its status as a private company, and a relatively short track record under its current organizational structure. Pelzer is a significant competitor in a relatively small, narrowly-defined market. Although the company's financial performance has been improving, it was free-cash flow negative in 2011, 2012, 2013 and the 12 months ended March 31, 2014. Fitch believes free cash flow is likely to remain under pressure for the remainder of 2014, but improved profitability and reduced capital spending needs are likely to turn free cash flow positive for the full year. Although Fitch views Pelzer's current liquidity position as adequate, many of the company's assets will be encumbered following the issuance of the proposed notes, which could impede the company's ability to access the capital markets for additional liquidity in a time of stress.

Currently, Pelzer's debt is primarily comprised of various bank loans, denominated in multiple local currencies that have been borrowed to support its global subsidiaries. Debt at March 31, 2014, totaled EUR166 million. Pelzer intends to simplify its capital structure in the near term with the issuance of the EUR230 million in senior secured notes that will replace much of its existing debt. Proceeds will also be used to purchase certain subsidiaries from Adler and repay intergroup loans from Adler, as well as pay down some factoring and other borrowings. Following the issuance of the new notes and the various follow-on transactions, Pelzer's debt will be approximately EUR250 million and will consist of the new notes, EUR13 million in subsidiary debt and EUR6.5 million in capital lease obligations.

The rating of 'BB/RR1' assigned to the proposed senior secured notes is based on Fitch's expectation that their recovery prospects would be in the 90% to 100% range in a distressed scenario. The proposed notes will mature in 2021 and will be guaranteed by most of Pelzer's subsidiaries. The guarantor subsidiaries comprise about 73% of Pelzer's consolidated revenue, 76% of its consolidated assets and about 69% of its consolidated EBITDA. The notes will be secured by a first priority interest in the assets and shares of the guarantor subsidiaries. Collateral for the notes will consist of all the capital stock of Pelzer; all the capital stock of each guarantor subsidiary; substantially all of the assets of the guarantor subsidiaries in the U.S., Mexico, Germany and the Czech Republic (excluding trade receivables); various intra-group loans; and bank accounts.

As of March 31, 2014, Pelzer's EBITDA leverage (debt /Fitch-calculated EBITDA) stood at 2.4x and FFO adjusted leverage was 3.2x. With the issuance of the new notes, total debt will increase, and Fitch expects EBITDA leverage at year-end 2014 to rise to approach the mid-3x range and FFO leverage could approach 5x, despite an expected increase in EBITDA as business levels grow on higher auto production and new business wins. Leverage is expected to trend down over the next several years as EBITDA increases. Debt is likely to remain relatively stable as the new notes are non-amortizing and the remaining subsidiary debt is likely to be refinanced. Fitch's forecast suggests EBITDA leverage could decline to the mid-2x range over the next four years.

Pelzer's liquidity at March 31, 2014 was adequate, with cash and cash equivalents of EUR25 million, down from EUR30 million at year-end 2013. Pelzer does not have a corporate revolving credit facility, but a number of its subsidiaries have various credit lines that they use for incremental liquidity. The most significant credit line is a BRL62 million revolving credit facility entered into by one of Pelzer's Brazilian subsidiaries. Fitch expects Pelzer's liquidity to remain adequate over the intermediate term as free cash flow turns positive on higher profitability and as the company retains about EUR5.4 million from its secured note offering on its balance sheet. Aiding free cash flow and liquidity will be Pelzer's limited capital spending requirements, which Fitch estimates will range from EUR20 million to EUR40 million per year over the intermediate term. As such, Fitch expects free cash flow to grow over the intermediate term, but Pelzer's free cash flow margin could remain in the low single-digit range through the period.

Pelzer's revenue grew 6.2% in 2013 to EUR885 million on higher auto industry production volumes and new startup business. Sales growth was strongest in the company's NAFTA and Asian regions. Pelzer's EBITDA margin (as calculated by Fitch) rose to 7.1% in 2013 from 6.7% in 2012 on the higher business levels and as the company gained traction on various cost reduction initiatives. Free cash flow was negative, however, at (EUR8.2) million in 2013, up from (EUR17) million in 2012, as EUR25 million in operating cash flow was offset by EUR33 million of capital expenditures. Looking ahead, Fitch expects free cash flow to turn positive in 2014 and continue to rise over the next several years as operating cash flow grows and as capital spending remains in-check. Over the past three years, Pelzer's ordinary capital spending has ranged between 3.1% and 5.1% of revenue, but the company is likely to spend relatively less over the intermediate term as it takes advantage of recent capacity additions to grow production levels at its existing plants.

Pelzer's pension related liabilities are relatively minor, as the company only offers defined-benefit pension plans in those countries where such plans are required. As of March 31, 2014, Pelzer's employee benefit liabilities, including pension requirements, totaled only EUR4.1 million. Of that amount, EUR1.5 million was comprised of unfunded liabilities related early retirement programs. Overall, Fitch views Pelzer's pension liabilities as manageable, given the company's liquidity position and cash generating potential over the intermediate term.

RATING SENSITIVITIES

Positive: Further developments that may, individually or collectively, lead to a positive rating action include:

--Reducing EBITDA leverage (debt/Fitch-calculated EBITDA), following the issuance of the new notes, to below 3.5x for a sustained period;

--Producing positive free cash flow;

--Increasing Fitch-calculated EBITDA margins to above 8% for a sustained period.

Negative: Further developments that may, individually or collectively, lead to a negative rating action include:

--An unexpected sharp decline in global auto production;

--A sustained period of negative free cash flow;

--A decline in the company's Fitch-calculated EBITDA margins to below 6% for a sustained period;

--An increase in EBITDA leverage (debt/Fitch-calculated EBITDA) to above 4.0x for a sustained period.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=840489

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Contacts

Fitch Ratings
Primary Analyst
Stephen Brown, +1 312-368-3139
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Chad Walker, +1 312-368-2056
Associate Director
or
Committee Chairperson
Michael L. Weaver, +1 312-368-3156
Managing Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Stephen Brown, +1 312-368-3139
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Chad Walker, +1 312-368-2056
Associate Director
or
Committee Chairperson
Michael L. Weaver, +1 312-368-3156
Managing Director
or
Media Relations:
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com