OREANDA-NEWS. S&P Global Ratings today revised its outlook on Netherlands-based packaging group Clondalkin Industries B. V. to negative from stable.

At the same time, we affirmed our 'B' long-term corporate credit rating on Clondalkin Industries.

We also affirmed our 'B' issue ratings on the $35 million revolving credit facility (RCF) due 2018 and $135 million senior secured first-lien term loan due 2020, issued by Clondalkin Acquisition B. V. The recovery rating on these facilities is '4', indicating our expectation of 30%-50% recovery prospects (in the lower half of the range) in the event of a payment default.

The outlook revision follows Clondalkin Industries' weaker-than-expected results in 2015 and in the first quarter of 2016, partly due to some one-off expenses and also noting that an uncertain macroeconomic environment has led us to further lower our base-case forecasts. Furthermore, interest accruing on the group's substantial shareholder loans will hamper further deleveraging potential. As a result, we now anticipate that fully adjusted leverage may not fall below 12x (or below 5x excluding shareholder loans) in 2016 from nearly 18x in 2015, whereas previously we had forecast that it would.

Our calculation of leverage includes shareholder loans of about €241 million (including accrued interest) at the Clondalkin Group Holding level at the end of 2015, which generate payment-in-kind (PIK) interest at 7.57%. No cash interest can be paid on these loans until redemption, which has so far been a support for the rating. Excluding these instruments, adjusted senior leverage at the end of 2015 was 7.5x, which was significantly weaker than we had expected (we had previously forecast that this would reduce to less than 5x). Our updated forecasts now suggest that leverage could remain above 14x over the coming years and more than 5x, excluding shareholder loans, which would weigh on the rating. Partly offsetting the very high leverage is Clondalkin Industries' strong cash interest coverage, with adjusted FFO cash interest cover of between 4x-5x.

We assess Clondalkin Industries' business risk profile as weak. Although the entity has market-leading positions and retains a good degree of geographical, product, end-market, and customer diversity, its overall scale is limited compared to peers--with 2015 revenues of just €396 million--and the flexible packaging sector is highly fragmented. Its profitability is also somewhat lower than the industry average, with adjusted EBITDA margins in the high single digits and potentially more volatile than the average; the entity is exposed to volatility in raw material and energy costs, which can cause disruptions in price and demand as customers re-stock or de-stock inventories while awaiting price stabilization.

In our base case, we assume: Flat-to-slightly-negative revenue growth driven by the group exiting low value-added contracts and partly offset by organic growth and new products;Adjusted EBITDA margins improving to around 8.0% from 5.9% in 2015 as the group focuses on higher margin products, while lower restructuring expenses and cost improvements measures take effect;Positive free operating cash flow generation of €15 million-€20 million, reversing slightly negative cash flows in 2015.Based on these assumptions, we arrive at the following credit measures:Improving adjusted debt-to-EBITDA that is nevertheless very highly leveraged at around 14x from 2016, compared to nearly 18x in 2015. This equates to leverage in the region of 5x-6x when excluding the group's shareholder loans. Funds from operations (FFO) to debt of about 1%-2%, or 13% when excluding the effect of shareholder loans and accrued interest. FFO cash interest cover that remains over 4x.

We assess Clondalkin Industries' liquidity as adequate. We forecast that its sources of liquidity will exceed its uses by more than 1.2x over the 12 months from March 31, 2016, supported by a largely undrawn RCF, strong cash balances, and limited debt maturities.

Principal liquidity sources for the 12 months from March 31, 2016 are as follows:Available cash balance of about €44 million as of March 31, 2016;Availability of $32 million (or about €28 million) under the $35 million committed RCF maturing in 2018; andOur forecast of unadjusted FFO of €25 million-€30 million. Principal liquidity uses for the 12 months from March 31, 2016 are as follows:No significant debt maturities until 2018, with only about €1 million due per year until the group's RCF matures;Seasonal working capital requirements and cash outflows in the first half of the year, followed by a reduction in the second half. We understand the peak cash requirement is about €15 million;Capital expenditure of about €13 million-€15 million; andNo further dividends or material acquisitions forecast.

The negative outlook reflects that we could consider a one-notch downgrade if anticipated earnings growth does not result in a sufficient improvement in Clondalkin Industries' credit ratios.

We could lower the ratings to 'B-' if credit ratios continue to fall short of our expectations, for instance if they were likely to remain highly leveraged even when excluding shareholder loans--for example debt-to-EBITDA remaining above 5x, or fully adjusted leverage of over 12.5x. We could also lower the rating if the group's cash interest coverage dropped below 2x, or there was pressure on the group's liquidity.

We could revise the outlook back to stable if we believed the group could sustain reduced leverage below 5x when excluding shareholder loans, while maintaining strong cash interest cover of over 3.5x, or if we believed FFO to debt could be sustained above 6%. We view this as achievable if Clondalkin Industries were able to consistently generate adjusted EBITDA in excess of €35 million.