OREANDA-NEWS. Fitch Ratings has downgraded the Long-Term Issuer Default Ratings on India-based paper maker Ballarpur Industries Limited (BILT) and its subsidiary Bilt Paper B. V. to 'B-', from 'B+' and placed the ratings on Rating Watch Negative (RWN).

BILT continues to face the twin challenges of high leverage and weak liquidity. We estimate that its leverage, measured by net debt to EBITDA with 50% equity credit for the perpetual debt, jumped to 10.3x in the financial year ended 31 March 2016 (FY16) from 7.8x in FY15. Its fixed-charge cover, including interest on perpetual securities, declined to 1.3x in FY16 from 1.5x in FY15.

We had earlier assumed that the company would be able to sell off its stake in Malaysia-based Sabah Forest Industries Bhd (SFI) by end-FY16 and use the proceeds to deleverage. However, the proposed deal to dispose of the stake has been terminated. In addition, prices and demand for paper have remained weak over the last few years. As a result, BILT's credit profile has deteriorated, which led to the downgrade. The RWN reflects the significant refinancing risks the company is facing as its free cash generation would be inadequate to meet upcoming debt maturities.

BILT's management continues to focus on reducing debt and addressing upcoming repayments, and the company has received a non-binding offer for two of its Indian units. The sale, if finalised, should improve liquidity. However, failure to address debt maturities in a timely manner through asset sales or refinancing will result in negative rating action.

KEY RATING DRIVERS

Weak Credit Profile: We estimate that BILT's leverage will remain high over the next three years at above 6x, assuming a high-single-digit revenue growth rate and a slight improvement in EBITDA margin. Its fixed-charge coverage is also likely to remain weak at below 2x. Fitch expects the company's free cash flow generation to be insufficient to service upcoming debt maturities. This exposes BILT to significant refinancing risk, unless the company is able to sell assets that are underperforming and use the proceeds to deleverage.

Potential Sale of Indian Assets: BILT has received a non-binding offer from JK Paper Ltd to acquire two of its units in Maharashtra state. The plant in Ballarpur has capacity of 299.5 kilo tonnes per annum (ktpa), and Ashti plant has capacity of 54 ktpa. The proposal is subject to further due diligence, negotiation and execution of definitive agreements.

The two units account for almost half of the paper-making capacity of subsidiary Ballarpur Graphic Paper Products Ltd. (BGPPL), which accounted for around 85% of BILT's consolidated EBITDA in FY16. While the sale of the units would inject liquidity and reduce debt, it would also materially reduce BILT's earnings. In addition, it would impact BILT's market position as the leading writing and printing paper producer in India.

Cyclical Business: Global paper prices have remained weak over the last three years reflecting the lower demand globally. Demand has been falling in the developed markets of North America and Europe, while growth in emerging markets, such as India and China, has been weak over the past few years and unable to offset the demand decline in developed markets.

Rayon Unit's Restart Delayed: BILT's rayon grade pulp manufacturing unit at Kamalapuram has remained shut since May 2014 due to adverse market conditions. The company plans to restart operations upon receipt of subsidies from the state governments of Telangana and Andhra Pradesh. The Telangana government has agreed to provide a subsidy of INR300m each year for seven years. BILT earlier planned to restart operations in 4QFY16, pending confirmation of a subsidy from the Andhra Pradesh government. The unit has been a drag on BILT's profitability over the past two years due to fixed costs related to the plant.

Strong Linkage with Subsidiary: Bilt Paper B. V's ratings reflect its strong operational and strategic linkages with the ultimate parent, BILT. Bilt Paper is in the same line of business as BILT and the two have a common treasury and management team. Bilt Paper holds a 99.99% stake in BGPPL, the key Indian operating entity, and a 98% stake in SFI. Bilt Paper accounts for over 85% of BILT's overall revenue and EBITDA.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Revenue growth of 8% each year on average from FY17

- Slight improvement in operating EBITDA margin to around 18% from FY17 (FY16: 17.5%)

- Restart of operations at the rayon unit in Kamalapuram from FY18, and gradual improvement in earnings at SFI

- Asset sales, which are used for debt repayment

- Absence of any major capex over the medium term

RATING SENSITIVITIES

The Rating Watch Negative will be resolved following a review of BILT's liquidity position once Fitch has more clarity about the company's asset-sale efforts, including the potential sale of its two Indian units.

Failure to address upcoming maturities in a timely manner through debt repayment using asset sale proceeds or refinancing will result in a downgrade.