OREANDA-NEWS. S&P Global Ratings today lowered its long-term corporate credit rating on Germany-based graphite and carbon materials producer SGL Carbon SE to 'CCC+' from 'B'. The outlook is stable.

At the same time, we lowered our issue rating on the €250 million seven-year 4.875% fixed rate senior secured notes due 2021 to 'B' from 'BB-'. The recovery rating on these notes remains '1'.

The downgrade reflects our expectation of a material deviation in performance in 2016 compared to our previous base case, in which we had expected EBITDA to improve from 2015 to S&P Global Ratings-adjusted €108 million, and free cash flow to recover back to neutral. We now expect about €70 million adjusted EBITDA this year, because of the depressed market for graphite electrodes, and significantly negative free operating cash flow (FOCF) of about €120 million on continued high restructuring cash-outs. We now view debt to EBITDA rising again to about 15x in 2016, similar to in 2014--which had lead the company to restore its balance sheet via a capital increase. We therefore regard the current capital structure as unsustainable, although we take into account the company's strategy to dispose its graphite electrodes business during 2016 as part of its determination to rebuild a stronger balance sheet.

Our EBITDA forecast for 2016 now factors in continued pressure on the steel markets, particularly the collapse in the price for graphite electrodes since last year, which will translate to substantially lower EBITDA from SGL's performance products division in 2016, in our view. We also continue to anticipate significant restructuring costs, including from discontinued operations, to weigh on FOCF in 2016. We expect that assets contemplated by the disposals will be reported as discontinued operations in 2016. The dip in FOCF is despite management's cut in capital expenditure (capex) materially below depreciation level for 2016.

We view SGL's two other divisions--namely carbon fibers & materials and graphite materials & systems--as more diversified, customer-specific, and profitable with around 12% EBITDA margin (as reported, before restructuring charges). We take into account that the company has now completed the ramp-up of its joint venture with BMW, although both segments' EBITDA contributions remain limited at this stage. For these reasons we continue to view the business risk profile as weak.

We view the current capital structure as unsustainable in the current depressed market for graphite electrodes. We do not make any assumption on the possible disposal proceeds, although we take into account that debt levels will remain very high compared to the two other divisions' projected EBITDA contribution.

Our base case assumes: 8% revenue decline in 2016 year-on-year, reflecting mostly pricing pressure and depressed volumes in the performance products division. Reported EBITDA of about €70 million-€75 million before nonrecurring items.€55 million capex. About €50 million nonrecurring cash-outs, and €15 million negative impact from discontinued operations (Hitco).Based on these assumptions, we arrive at the following credit measures:Negative €120 million-€130 million FOCF. About 15x adjusted debt to EBITDA. The stable outlook balances the lack of near-term liquidity pressure, the potential asset sale--albeit uncertain--and the extent to which this can contribute to restoring leverage to a more sustainable level, against projected negative FOCF and ongoing liquidity deterioration we expect in the coming quarters.

We could lower the rating absent a recovery in FOCF, notably from higher-than-expected losses in the graphite electrodes business, or from higher-than-expected restructuring charges. We could also lower the rating if liquidity deteriorated at a faster pace, and absent proactive and timely refinancing plans for the January 2018 maturity.

We could raise the rating if asset disposals resulted in a materially improved capital structure, in combination with continued growth and profitability resilience at SGL's graphite specialties and carbon fiber's EBITDA. A recovery in FOCF, post restructuring charges, and a firming liquidity position--together with clear refinancing plans for the 2018 convertible bond maturity--could also provide rating upside.