CHICAGO--(BUSINESS WIRE)--Fitch Ratings has placed the ratings for Harsco Corporation (Harsco) (NYSE: HSC) on Rating Watch Negative following the announcement that the company is exploring the separation of the Metals and Mining businesses. Fitch's actions affect $1 billion of total debt, including $200 million of undrawn amounts under the revolving credit facility (RCF) after the company drew on the RCF to fund the repayment at maturity of $250 million of senior notes on Oct. 15, 2015 (senior notes repayment). A full list of current ratings follows at the end this release.
The Negative Watch reflects Fitch's belief the potential separation will reduce the diversification and scale of Harsco's revenues and profitability, given the company's already small size and that the Metals and Mining (M&M) segment represents roughly two-thirds of revenues and one-third profitability on a trailing 12 month (TTM) basis. Annual revenues will be $625 million to $675 million versus roughly $1.8 billion on a pre-separation basis, while operating profit margins will be in the low double digits, versus high single digits presently.
The Negative Watch also incorporates uncertainty around the ultimate capital structure and financial policies of the remaining Harsco (Remainco), which will be comprised of the faster growing and more profitable Rail and Industrials segments, as well as a minority interest in the Brand joint venture (JV). Fitch believes potential net proceeds from the separation may be constrained by weak demand facing M&M's businesses and limited number of strategic buyers, potentially reducing potential debt reduction at Remainco.
In connection with earnings announcement for the quarter ended Sept. 30, 2015, Harsco announced it is exploring options for the separation of the M&M business, which could include an outright sale or spin-off, as well as no separation at all. The company will commence the review in the coming weeks with no time table on reaching a decision. Fitch expects to resolve the Negative Watch upon the company conclusion of the review with a likely outcome of at least a one-notch downgrade.
Harsco's operating results for the quarter ended Sept. 30, 2015 were roughly in-line with Fitch's expectations, which included ongoing weakness in steel production, energy markets affecting the Industrials businesses and the timing of equipment sales in Rail. Fitch expects Harsco's top line to remain pressured and decline by low double digits in 2015. Nonetheless, ongoing cost reduction actions, particularly in M&M, should mitigate a portion of the impact on profitability, which Fitch estimates will decline in the mid-teens for the year.
Given the weak demand environment, Fitch expects credit protection measures will remain weak over at least the near-term and Fitch estimates total leverage (total debt to operating EBITDA) was 3.6 times (x) for the latest 12 months (LTM) ended Sept. 30, 2015, versus 2.9x exiting 2014. Interest Coverage (Operating EBITDA to gross interest expense) should also remain pressured and was a Fitch estimated 5.2x for the LTM ended Sept. 30, 2015, versus 6.5x for 2014.
Harsco also reduced the per share dividend from $0.20 to $0.05 to maximize financial flexibility within the context of the weak demand environment. Fitch expects this, in conjunction with lower capital spending, should enable Harsco to achieve break-even FCF through the intermediate term, which is particularly important given: i) the majority of cash balances are outside the U.S. and could be subject to tax liabilities if repatriated and ii) only $200 million remains undrawn under the RCF following the senior notes repayment.
KEY RATING DRIVERS
The ratings are supported by:
--Fitch's expectations for the company's operating performance to strengthen with an improving sales mix from re-pricing or exiting underperforming contracts and increased efficiencies following the completion of the turnaround in Metals;
--Strong market positions in core growth end markets, including resource recovery and environmental services;
--Fitch's expectations for faster growing non-Metals businesses, Industrial and Rail, which should represent roughly 35% of total revenues but more than 60% of projected contribution margin, to strengthen Harsco's operating profile over time.
Rating concerns include:
--Fitch's expectations for weak annual FCF through the intermediate term, driven by weak operating performance in Metals and lower demand in the Industrial segment. Fitch expects operating performance in Metals will strengthen as the company achieves costs savings from its ongoing restructuring and efficiency initiatives;
--Expectations for sustained higher total leverage, despite Harsco's historically conservative financial policies, given lower profitability and weak FCF;
--Subdued top-line growth prospects in Metals over the intermediate term, given low global steel production, sales declines from exiting underperforming contracts and weak commodity prices for both Metals and Industrial.
--Metals segment returns to positive revenue growth in 2017 and reduces negative revenue growth to mid-single digits in 2016;
--Longer-term revenue growth for Rail and Infrastructure are +3%;
--Harsco achieves targeted cost savings of $35 million to $40 million in 2016, resulting in profit margin expansion despite negative revenue growth through 2016;
--Capital spending is 9% of revenues in 2016-2017, while customer advances are flat at lower levels.
Negative rating actions could occur if Fitch expects:
--The company completes the separation of the M&M businesses, given reduced scale and diversification; or
--The company decides to not separate the M&M businesses and Fitch expects total leverage will remain above 3x or negative FCF through the intermediate term.
Although an unlikely outcome, the Negative Watch could be resolved and ratings affirmed at current levels if Harsco:
--Retains the M&M businesses; and
--Commits to returning total leverage to 3x in the near-term.
Pro forma for the Senior Notes Repayment, total liquidity at Sept. 30, 2015 was sufficient and consisted of:
--$60 million in cash and cash equivalents (the vast majority of which was located outside the U.S.);
--$200 million available under the $500 million senior secured Revolver expiring 2017.
Fitch expects break-even FCF through the intermediate-term should improve liquidity, given negative FCF in recent years.
Total debt, pro forma for the senior notes repayment, the amended Credit Facility, was $868 million at June 30, 2015 and included:
--$300 million of borrowings under the senior secured Revolver;
--$450 million of senior notes due 2018;
--$72.4 million of other borrowings.
Fitch has assigned an 'RR4' Recovery Rating to the senior credit facility and unsecured notes. Fitch assumes persistent operating weakness rather than onerous debt service would drive the company to reorganization. Fitch believes this weakness would involve exiting incremental metals contracts and reduced competitiveness of new products in industrial markets. Fitch assumes a reorganization operating EBITDA of $175 million and a reorganization multiple of 4x, resulting in average recovery on the senior unsecured debt.
FULL LIST OF RATING ACTIONS
Fitch has placed the following ratings for Harsco on Rating Watch Negative:
--Long-term IDR 'BB+';
--Senior unsecured RCF 'BB+/RR4';
--Senior unsecured debt 'BB+/RR4'.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)