CHICAGO--(BUSINESS WIRE)--Fitch has affirmed the ratings, including the long-term Issuer Default Rating (IDR), for Harsco Corporation (Harsco) (NYSE: HSC) at 'BBB-'. The Rating Outlook remains Negative. Fitch's actions affect $0.8 billion of total debt, including the revolving credit facility (RCF).
The ratings and Outlook reflect Fitch's expectation Harsco's operating performance and free cash flow (FCF) will remain weak over at least the near-term due to the ongoing turnaround of the Metals segment, which represents nearly two-thirds of consolidated revenues following the divestiture of the Infrastructure segment at the beginning of 2014.
Fitch anticipates flat revenue growth over the near-term, with unprofitable Metals contract churn and subdued global steel production offsetting solid demand in the Rail and Industrial segments. Longer-term, Fitch anticipates low single digit revenue growth, driven by faster growth in Industrial and Rail markets.
Profitability should continue to improve, albeit from a lower base level following the Infrastructure divestiture. Lower fixed cost structure from headcount reductions and footprint optimization in Metals and a richer sales mix will drive operating EBITDA margin to more than 16% through the intermediate-term from just over 14% for 2013.
Nonetheless, Fitch expects flat FCF over at least the near-term, due mainly to lower operating EBITDA following the Infrastructure divestiture, cash restructuring charges and elevated capital spending to support growth opportunities in Rail, Industrial and resource recovery and environmental services. Beyond the near-term, the ratings and outlook reflect Fitch's expectations for modest annual FCF approaching $100 million.
Credit protection measures should strengthen through the forecast period from profitability growth. Fitch estimates total leverage (total debt to operating EBITDA) will remain below 2.5 times (x) and was just under this level for the latest 12 months (LTM) ended September 30, 2014. Interest coverage (operating EBITDA to gross interest expense) will exceed 7.5x and was just over this amount for the LTM ended September 30, 2014.
Fitch believes the company's commitment to conservative financial policies remains critical to the rating during the turnaround.
Solid operating performance in the higher margin Industrial segment (20% of sales) should continue, driven by increasing penetration in international markets. Developed markets have stabilized and are contributing to positive operating momentum. Fitch anticipates operating margin will remain in the mid-teens although may continue to decline with an increasing mix of international sales.
Expectations for increased diversification in Rail, which represents 15% of consolidated revenues, should mitigate concerns about uneven revenues and cash flows. Fitch anticipates operating profit margin will be in the mid-teens on average over the longer-term. Harsco entered into a number of new contracts that should drive revenue growth in the near-term following the wind down of a large scale project with the Chinese government in 2014.
Harsco's Infrastructure sale to a joint venture (JV) with Clayton, Dubilier & Rice (CD&R) at the end of 2013 alleviated some pressure on FCF and resulted in $300 million of cash proceeds. There are no contingent liabilities for Harsco related to the JV other than a requirement for Harsco to make annual cash or 'in-kind' payments approximating $15 million after-tax to CD&R, over at least the intermediate term. Finally, Harsco can participate in any upside to the JV, which combined Harsco's Infrastructure business with CD&R's Brand Energy & Infrastructure Services, Inc., given Harsco's 29% equity stake in the JV.
Harsco's cash pension contributions should be $38 million in 2014. Net pension obligations decreased to $238 million at the end of 2013, down from $384 million at the end of 2012, due to higher discount rates. Qualified and non-qualified U.S. plans were 82% funded at the end of 2013, while international plans were 80% funded.
KEY RATINGS DRIVERS
Rating concerns include: i) continued weak operating performance in Metals with the benefits of extended restructuring initiatives constraining revenue growth and weighing on FCF, despite expectations for more profitable customer contracts; ii) uneven revenues and FCF in the Rail business, given their project-oriented nature; and iii) reduced customer and geographic diversification following sale of Infrastructure and Metals restructuring with a greater reliance on global steel production, which remains weak.
The ratings are supported by: i) Fitch's expectations for the company's operating profile to strengthen with an improving sales mix and following the completion of the Metals restructuring, potentially driving operating EBIT margin to the high single digits; ii) strong market positions in core growth end markets, including Rail and Industrial, as well as resource recovery and environmental services; and iii) management's commitment to financial discipline through the Metals turnaround.
Negative ration actions could occur if:
--Harsco's Metals restructuring does not yield FCF Fitch anticipates negative FCF beyond 2014, from inadequate cost reductions, greater than anticipated revenue declines as Harsco restructures contracts in the Metals & Mining business, or weaker than forecasted contribution from the Industrial and Rail segments;
--Expectations for total leverage sustained above 2.5x, driven by weaker than anticipated operating performance or debt financed acquisitions.
Fitch could stabilize the ratings if the company realizes positive FCF approaching $100 million, driven by the combination of solid growth in Rail and Industrial and resumption of revenue growth and completion of restructuring in Metals.
Fitch believes liquidity at Sept. 30, 2014 was sufficient and included:
--$72.6 million of cash and cash equivalents, of which $3.6 million was located in the U.S.,
--$485 million of availability under a $525 million revolving bank credit facility (RCF) expiring in 2017.
Expectations for positive annual FCF beyond the near-term also should support liquidity. Cash deployment for acquisitions could accelerate following the sale but Fitch continues to believe share repurchases will be minimal while Harsco focuses on organic growth.
Total debt at September 30, 2014 included:
--$40 million of borrowings under the RCF;
--$250 million of senior notes maturing in 2015;
--$450 million of senior notes due 2018.
Fitch has affirmed the following ratings for Harsco:
--IDR at 'BBB-';
--Senior unsecured credit facilities at 'BBB-';
--Senior unsecured debt at 'BBB-'.
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