Moody's changes outlook on UPM-Kymmene to positive, Ba1 CFR affirmed
Moody's Investors Service, ("Moody's") has today changed to positive from stable the outlook on all ratings of UPM-Kymmene (UPM) and its subsidiary UPM-Kymmene Finance B.V.. Concurrently, the company's Ba1 corporate family rating (CFR), Ba1-PD probability of default rating (PDR), the Ba1 ratings on the various senior unsecured debt instruments and the (P)Ba1 senior unsecured MTN programme ratings of UPM and UPM-Kymmene Finance B.V. have been affirmed.
RATINGS RATIONALE
"Today's outlook change to positive reflects the achieved track record in financial performance and resilience of UPM's business model over the past years despite challenging economic conditions as well as our expectation of sustainability in recent performance improvements, that should allow the group to achieve and maintain credit metrics in line with an investment grade rating over the next 12-18 months" says Matthias Volkmer, a Moody's Vice President -- Senior Analyst and lead analyst for UPM. "We note that UPM's strategy of profitable growth may incorporate sizeable investments as well as potential M&A but understand that management is unlikely to deviate from the current conservative financial profile until UPM's business mix has fundamentally changed to allow for a
higher through-the-cycle financial leverage supported by stable profit and cash flow generation", Volkmer added.
The Ba1 rating reflects UPM's (i) solid business risk profile, in terms of its size, as one of the leading paper and forest products companies in Europe; (ii) diversified activities in communication paper grades, wood and energy operations and label materials; and (iii) presence in three geographic regions, although with a major share from the mature European and North American paper market. UPM's good vertical integration into forest, pulp and energy is a further supportive factor of its business profile, and has sheltered the company's paper and specialty paper production somewhat from market price fluctuations of main input factors relative to its peers. In terms of capital structure, we note that UPM has been strongly positioned at the Ba1 rating level for some time with adjusted
preliminary debt/EBITDA of about 2.4x (excluding certain fair value adjustments to biological assets during Q315) and preliminary RCF/debt of around 23% as of December 2015 and a strong liquidity profile.
Moody's notes that UPM's deleveraging including substantial debt repayments in recent years has helped rebalance the interests of creditors and shareholders while another positive rating factor has been the gradual reduction of UPM's dependence on the mature European and North American paper markets, where UPM generated around 50% (down from 53% in 2014) of its sales yet only 15.8% ( down from 30% in 2014) of its EBITDA during 2015 (as reported). The graphic paper market continues to be in structural decline with shrinking volumes due to digital substitution. Weak pricing levels as a result of a highly competitive market environment with a significant periodic overcapacities in most paper grades and continued high input costs are weighing on its margins. In response, UPM's strategy is to achieve more than 50% of its sales from growth businesses by the end of this decade, such as paper production in less developed markets, bio refining and label production (per FY 2015 about 48% up from 44% in FY2014). However, these shifts in UPM's business profile will only gradually contribute to this goal in the short to medium term, leaving UPM vulnerable to the weak state of developed paper markets for the time being. In addition, the industry's inherent cyclicality has historically resulted in considerable volatility of UPM's credit metrics, although we note that volatility was clearly lower compared to other `Ba' rated peers.
OUTLOOK
The positive outlook reflects our expectation of UPM being able to sustain its profitability during 2016 and onwards, allowing the group to maintain a through-the-cycle leverage well below 3.0x debt/EBITDA while management continues to pursue a balanced approach towards shareholders and creditors interest, in particular with regards to dividends, potential M&A activity and growth investments.
WHAT COULD CHANGE THE RATING UP/ DOWN
Further positive pressure could result from (1) further reduction of UPM's dependence on the mature European and North American paper markets and (2) a continued track record of a sustainable and balanced financial policy maintaining financial metric commensurate with an investment grade rating including EBITDA margins in the mid to high teen percentages translating into retained cash flow/debt above 20% and a leverage of debt/EBITDA below 3 times through the cycle.
Although unlikely at this juncture, Moody's could consider downgrading UPM if the group's profitability were to come under pressure, resulting in its debt/EBITDA ratio rising towards 4x or higher with EBITDA-margins below the mid-teens and periods of negative free cash flow generation. Moreover, negative ratings pressure could develop if UPM were to engage in larger transactions and fail to return to a debt/EBITDA ratio comfortably below 4.0x in the intermediate term.
