Rating Action Overview
- Orica has announced a material downward revision to its earnings outlook, primarily due to headwinds from trade disruptions to Australian thermal coal and the continued impact of COVID-19.
- We now forecast Orica's fully adjusted FFO-to-debt ratio to remain below the downgrade trigger of 30% for the fiscal year ending Sept. 30, 2021.
- On March 2, 2021, S&P Global Ratings revised its outlook on Orica Ltd. to negative from stable. We also affirmed the 'BBB' long-term issuer credit rating on the company, 'A-2' short-term issuer credit rating on the company and 'BBB' issue credit rating on Orica's debt.
- The negative outlook reflects the risk that Orica's credit metrics will remain stretched beyond the current fiscal period.
Rating Action Rationale
The negative outlook reflects our view that Orica's credit metrics are likely to remain outside our thresholds for the 'BBB' rating in fiscal 2021. Trade tensions impacting the Australian thermal coal sector and continued impact of COVID-19 across Latin America and parts of Europe, Middle East, and Africa will adversely impact Orica's earnings during the first half of fiscal 2021. The pace of recovery may take time and, as a result, we expect Orica's fully adjusted ratio of funds from operations (FFO) to debt to remain below the downward trigger of 30% for the year ending Sept. 30, 2021.
The recovery in the Australian coal thermal market may take time. Thermal coal demand in the Australian market has been adversely affected by trade tensions between Australia and China. Despite signs of excess supply take-up by other countries, the timing of the recovery remains uncertain.
We expect Orica's trade working capital position to improve from fiscal 2021 following the rollout of the SAP system. Orica's operating cash flows and balance sheet were adversely impacted by trade working capital movements associated with the initial implementation of the SAP system in fiscal 2020. We expect the group's balance sheet to strengthen in the second half of fiscal 2021 as residual implementation issues around the software are resolved.
The recovery path from COVID-19 is likely to be uneven between regions. Key developing markets including Latin America, Africa, Indonesia, and Mexico may take longer to recover than developed markets of Australia, the U.S. and Canada. S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Orica has a solid track record of prudent balance sheet management, operational flexibility, and rating stability. In our opinion, the company remains committed to maintaining leverage metrics consistent with the 'BBB' rating. Moreover, we believe Orica has a number of financial levers available to support its financial metrics should operational weaknesses persist.
Outlook
The negative outlook reflects the risk that Orica's credit metrics will remain stretched beyond the current fiscal period. In the event that financial metrics do not self-correct, we expect Orica to utilize various financial levers to restore its key credit metrics.
Downside scenario
We could lower the rating if we forecast the company's fully adjusted FFO-to-debt ratio to remain below 30%, or if the debt-to-EBITDA ratio remains about 3x, for the year ending Sept. 30, 2022.
Upside scenario
We could revise the outlook back to stable if we expect the company to restore its financial profile in line with our rating expectations, including FFO to debt sustained above 30% and debt to EBITDA below 3x.
Company Description
Orica manufactures and distributes commercial blasting systems, and mining and tunneling support systems to the mining and infrastructure markets in Australia, the U.S., and internationally. Its products include bulk systems, electronic blasting systems, initiating systems, packaged explosives, and blasting services for surface and underground mining, civil tunneling, quarrying, construction, and oil and gas businesses.
Our Base-Case Scenario
Assumptions
- GDP growth in Orica's key markets: Australia--4.0% in 2021, 3.2% in 2022; Asia-Pacific--6.8% in 2021, 4.7% in 2021; U.S.--4.2% in 2021, 3.0% in 2022; Latin America--4.1% in 2021, 3.1% in 2022; Eurozone--4.8% in 2021, 3.9% in 2022;
- Ammonium Nitrate product volume contraction in low single digits for fiscal 2021, from baseline 2020 actual volumes of 3.8 million tons;
- Revenue contraction in the low single digits in 2021, impacted by softness in Australian thermal coal market and COVID-19 uncertainty in key regions of Latin America, Europe, and Africa;
- Adjusted EBITDA margins to improve toward 17% in fiscal 2021, from 16.2% in 2020;
- Capital expenditure (capex) of A$350 million-A$400 million in fiscal 2021, for sustenance, growth, SAP stabilization, the Burrup plant, and the Exsa S.A. integration;
- Minimal working capital changes in 2021, from the adverse working capital changes reported in 2020 as a result of initial implementation of the SAP system; and
- Dividend payout ratio at the lower end of 40%-70% of underlying earnings.
Based on these assumptions we arrive at the following credit metrics:
- S&P Global Ratings' adjusted debt-to-EBITDA approaching 3x in 2021, and decreasing toward 2.5x in 2022;
- S&P Global Ratings' adjusted FFO-to-debt remaining below 30% in 2021, and increasing above 30% in 2022.
Liquidity
We assess Orica's liquidity as strong. We expect the company's liquidity sources to exceed funding uses by more than 1.5x over the 12 months ending Sept. 30, 2021. We expect liquidity sources less uses to be positive even if the company's EBITDA were to decline 30% from our forecast under stress conditions.
Orica's substantial undrawn committed facilities, FFO, and cash holdings support its liquidity. The company continues to maintain strong bank relationships and a generally high standing in the credit markets. This has enabled it to maintain access to offshore debt markets.
As of Sept. 30, 2020, the group had the following liquidity profile over the following 12 months:
Principal liquidity sources:
- Undrawn credit facilities maturing beyond 12 months of about A$1.3 billion;
- FFO in the range of A$500 million-A$520 million; and
- Cash balance of about A$921 million.
Principal liquidity uses:
- About A$615 million of maturing debt in the 12 months ending Sept. 30, 2021;
- Capex of about A$350 million-A$400 million in the period; and
- Dividend payout at the lower end of 40%-70% of underlying earnings.
Covenants
Compliance expectations
We expect Orica to remain in compliance with covenants while maintaining sufficient headroom over the next 12-24 months.
Requirements
The group has sufficient headroom for forecast EBITDA to decline by 30% without a breach of covenant tests. The debt covenants are typical negative pledge arrangements and incorporate a gearing covenant below 57.5% and interest coverage above 2.0x.
Ratings Score Snapshot
Issuer Credit Rating: BBB/Negative/A-2
Business risk:
- Country risk: Low
- Industry risk: Low
- Competitive position: Satisfactory
Financial risk:
- Cash flow/Leverage: Intermediate
Anchor: bbb
Modifiers
- Diversification/Portfolio effect: Neutral (no impact)
- Capital structure: Neutral (no impact)
- Liquidity: Strong (no impact)
- Financial policy: Neutral (no impact)
- Management and governance: Satisfactory (no impact)
- Comparable rating analysis: Neutral (no impact)
Related Criteria
- General Criteria: Group Rating Methodology, July 1, 2019
- Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
- General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
- Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
- Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
- General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
- General Criteria: Methodology: Industry Risk, Nov. 19, 2013
- General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
- General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
Ratings List
Orica Ltd. | ||
Ratings Affirmed; Outlook Action | ||
---|---|---|
To | From | |
Orica Ltd. |
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Issuer Credit Rating | BBB/Negative/A-2 | BBB/Stable/A-2 |
Ratings Affirmed | ||
Orica Finance Ltd. |
||
Senior Unsecured | BBB | |
Commercial Paper | A-2 |
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Primary Credit Analyst: | Aldrin Ang, CFA, Melbourne + 61396312006; aldrin.ang@spglobal.com |
Secondary Contact: | Graeme A Ferguson, Melbourne + 61 3 9631 2098; graeme.ferguson@spglobal.com |
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