OREANDA-NEWS. Fitch Ratings has affirmed bathroom ceramics and fittings producer Ideal Standard International SA's (ISI) Long-Term Issuer Default Rating (IDR) at 'CC' and Short-Term IDR at 'C'. A full list of rating actions is available at the end of this commentary.

The affirmation reflects ISI's unsustainable capital structure, high liquidity risk and substantial refinancing risk. We do expect limited deleveraging before the group's bullet maturity in 2018, as growing funds from operations (FFO) are likely to be offset by the potential issue of EUR80m first-lien notes (AAA notes) notes and large PIK interest on existing debt.

Liquidity challenges will arise if the group's EUR25m super-senior revolving credit facility (RCF) is not refinanced before maturity in May 2017 or if the intended EUR80m AAA senior secured notes cannot be drawn from 1 January 2017. Although not part of Fitch's rating case, ISI is highly unlikely to be able repay the RCF and fund working capital without the AAA notes, leading to imminent default. However, the issue of the AAA notes requires prior consent by either of ISI's sponsors, Bain Capital or Achorage Capital Group, LLC.

We expect solid trading over the next 12 to 18 months to partially mitigate some of these credit risks. Management's refocus on brand and more resilient, innovative products is credit-positive in the long-term, but additional investments will put further near-term pressure on credit metrics.

KEY RATING DRIVERS

Unsustainable Capital Structure

The group's unsustainable leverage and excessive refinancing risks constrain the ratings, despite FFO improvement. We expect FFO adjusted gross and net leverage to remain in the double digits until the maturity of the senior secured notes in 2018, due to the intended AAA EUR80m notes and PIK interest on its existing debt which accrues at 15.75% and 17.75% annually. Free cash flow (FCF) is likely to remain neutral-to-negative, providing support to neither leverage reduction nor to liquidity.

Trading Performance Improving

Fitch expects modest revenue growth and flat-to-improving margins, driven by recovering construction activity in Europe and receding restructuring costs. We forecast healthy growth in two thirds of ISI's end-markets for the remainder of the year, although the UK, where 27% of revenues are generated, will slow down. We expect modest growth in ISI's other core-markets, France, Italy and Germany to continue in 2016, based on trading results in 1Q16 and 2015, which were ahead of our expectations. Revenue for 2015 grew 4.6% yoy (at constant FX) and Fitch-calculated EBITDA margin (post restructuring costs) improved to 9.9% from 2.6%.

Operational Restructuring Complete

ISI is better positioned to benefit from its leading market positions, following the completion of its multi-year restructuring programme. The group owns a portfolio of strong brands and ranks first or second in various European ceramics and fittings markets, but EBITDA has historically lagged peers, due to higher cost manufacturing and restructuring charges during the years of its operational turnaround.

Premium Strategy Strains Metrics

Fitch expects ISI's strategy to focus on higher-margin, less volatile products to strengthen the business against price competition. Measures include building the brands, new product innovation and a rebalancing of the product portfolio. However, Fitch cautions that the intended AAA notes to fund management's business plan will strain the group's already stretched credit metrics.

Going Concern Recovery

Fitch has altered its approach to recoveries to going-concern, from balance sheet liquidation. This follows the improvements in ISI's trading and cost structure, which leads to a higher recovery for creditors on a going concern basis compared with balance sheet liquidation.

As a result Fitch calculates above-average recoveries for ISI's AA senior secured notes, resulting in a rating of 'CCC'/'rr2'/88%. The rating for ISI's A and B senior secured notes is 'C'/'rr6'/0%. Our recovery is based on an estimated post-distress EBITDA of EUR35m (adjusted to reflect 60% stake in MENA) as a minimum required for the company to continue operating as a going concern. We also apply a 5.0x distress enterprise value /EBITDA multiple, consistent with ISI's peers, and deduct a 10% administrative charge.

We expect the issue of the AAA notes to result in the downgrade of the 'AA' notes to 'C'/rr6/0%, as we expect the new issue to subordinate the existing senior secured notes. The AAA notes will rank junior only to the super-senior RCF and senior to all other debt in the capital structure.

KEY ASSUMPTIONS

Modest revenue growth driven by slow recovery in end-markets.

Flat-to-improving margins from improved capacity utilisation, lower production costs and receding restructuring charges.

FCF constrained by growing capex, taxes and working capital needs.

EUR80m AAA notes will be issued in 1H17.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

Significant margin improvement, with sustainable positive FCF and material deleveraging leading to a manageable capital structure.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

Imminent default from inability to service near-term interest or principal maturity, or further debt restructuring measures.

LIQUIDITY

Liquidity is poor. Cash of EUR49m at end-1Q16 will be sufficient to cover around EUR30m in intra-year working capital swings. However, the group is reliant on the roll-over of EUR29m in local credit facilities, the draw-down of EUR80m new AAA notes and the refinancing of a fully-drawn EUR25m RCF in May 2017. ISI's working capital typically unwinds in 2H and is lowest at end-4Q. This provides some headroom until the AAA notes are available from 1 January 2017 to cover working capital build-up in 1Q16. However, ISI may not be able to repay the RCF without the issue of the AAA notes, if the RCF cannot be extended or refinanced. However, the issue of the AAA notes will require the prior consent of Bain Capital or Achorage Capital Group, LLC.

FULL LIST OF RATING ACTIONS

Long-Term IDR: affirmed at 'CC'

Short-Term IDR: affirmed at 'C'

Super senior AA notes: affirmed at 'CCC'/'RR2'

Senior secured A notes: affirmed at 'C'/'RR6'

Senior secured B notes: affirmed at 'C'/'RR6'