OREANDA-NEWS. S&P Global Ratings said today that it affirmed its 'BB' long-term corporate credit rating on Refresco Group NV (Refresco). The outlook is stable.

At the same time, we affirmed our 'BB' issue rating on the €722 million term loan B due 2021 with a recovery rating of '3', reflecting our expectation of meaningful (50%-70%) recovery in the event of a payment default, at the higher end of the range.

The affirmation follows Refresco's recent acquisitions, including Dutch co-packing business DIS and U. S.-based Whitlock Packaging, after the company increased its syndicated loan facility to €722 million. The new facility now expires in July 2021 and includes a revolving credit facility (RCF) of €150 million, which is currently undrawn. We see the acquisitions as consistent with the company's buy-and-build strategy and expect earnings contributions over the next 12-18 months to support our significant financial risk profile assessment.

Refresco remains a market leader in the fragmented bottling and packaging industry. The group enjoys strong positions in large European consumer markets including Germany, Benelux, France, Italy, the U. K., and Iberia. We view these markets as being relatively mature, however, with the group's investment in modern manufacturing plants, increased productivity, and variety in packaging formats helping to maintain a competitive advantage over other players.

The group has historically had significant exposure to private-label production, which generally has lower margins and shorter contract profiles than branded production. Following the recent Whitlock and DIS acquisitions, however, the group is expected to improve the proportion of volumes from branded customers to above 30% from around 20% at year-end 2015. Refresco will also enter a new geographic market, the U. S. This is expected to support the group's overall growth prospects as North America is the largest soft drinks market globally, with higher per capita consumption rates than Western Europe. There is also the potential for further acquisitions as many U. S. players are smaller and regionally focused, and if the group is able to leverage their existing customer relationships it could help to drive increased volumes.

We note however, that Refresco continues to be exposed to volatility in input prices, including raw materials such as juice concentrate and sugar and packaging materials including PET, liquid paper board, and aluminum cans. The group mitigates some of this exposure with the use of forward purchasing in its procurement and pass-through mechanisms in its contracts. The increased proportion of co-packing volumes should also support working capital volatility going forward as these volumes are predictable and the raw materials are often provided by their customers. The growing trend of branded producers outsourcing the bottling function supports growth prospects in Refresco's key markets, but we note that the group does not have any proprietary brands and as such is not able to maximize its margins by employing a marketing strategy. We also view Refresco as relatively small compared with some European bottlers with larger revenue bases. This fact, combined with the company's limited pricing power, constrains our current business risk profile assessment to fair.

We continue to assess the financial risk profile as significant. This reflects our expectations that the group will record S&P Global Ratings-adjusted debt to EBITDA of around 3.0x over the next 12-18 months. In addition to the €722 million term loan B, our calculation of adjusted debt also includes our customary adjustments for operating leases and post-retirement obligations in excess of €100 million. We also now give benefit for surplus cash being held following the successful IPO transaction in May 2015 and management's public commitment to reported net leverage not exceeding 3.0x in the long term. We expect the company to marginally improve its profitability given the increased co-packing volumes with careful working capital management helping the cash conversion cycle. For 2016, we forecast adjusted EBITDA of €240 million-€250 million and adjusted free operating cash flow (FOCF) of €85 million-€100 million, with modest growth in 2017 supported by the full-year contribution of recent acquisitions and organic top-line growth. The group benefits from low cost of debt--the highest margin linked to the syndicated loan is 2.6%–-which means that we expect the group to enjoy EBITDA interest coverage above 8.0x in our forecasts. We also closely monitor the FOCF-to-debt and discretionary cash flow-to-debt ratios in our forecasts given the importance of capital investment for operating activity and Refresco's new financial and dividend policy as a public company. We expect FOCF to debt to remain below 15% over the next 12-18 months, which we view as commensurate with the 'BB' rating, as we expect adjusted FOCF to be around €100 million in 2017 and 2018.

In our base case, we assume:Revenue increases of 2.0%-5.0% for the next three years, driven by bolt-on acquisitions and supported by organic growth, especially in the U. S. We expect the group to continue to acquire accretive targets in its drive to increase enterprise value. Adjusted EBITDA of €240 million-€250 million in 2016 and steadily improving thereafter, reflecting top-line growth, a greater proportion of co-manufacturing volumes, and management's measures to improve cost efficiency and productivity. Modest outflows of working capital, reflecting the growing sales volumes as the group penetrates the U. S. market. Capital expenditure (capex) of about €80 million-€90 million annually in 2017 and 2018.Acquisitions of €200 million-€250 million in 2016 and €30 million–€80 million annually over the next two years. Shareholder dividends of about 35%-45% of net income. Based on these assumptions, we arrive at the following credit measures: Revenues of €2.10 billion-€2.15 billion in 2016, rising to above €2.2 billion in 2017.Adjusted EBITDA margins of 11%-12% in 2016 and 12%-13% 2017.S&P Global Ratings-adjusted debt to EBITDA of around 3.0x in 2016 and 2017.S&P Global Ratings-adjusted EBITDA interest coverage of above 8x and FOCF to debt of 12%-15% in 2016 and 2017. The stable outlook reflects our view that Refresco will improve its profitability metrics, driven by management's continued focus on operational efficiency and supported by a greater proportion of co-packing volumes in group sales. We expect modest bolt-on acquisitions to augment low-single-digit organic growth, and we expect management to adhere to its publicly stated leverage target of 2.5x-3.0x reported net debt to EBITDA. We expect that the group's adjusted debt to EBITDA ratio will be around 3.0x and FOCF above €90 million over the next 12-18 months. We also forecast that EBITDA interest coverage will remain above 6.0x and FOCF to debt will be 10%-15%, a level we consider commensurate with the 'BB' rating.

We could consider lowering the ratings if the credit ratios deteriorate or the group's liquidity comes under pressure, due to debt-financed acquisitions or large shareholder distributions. Weaker credit ratios could also be a result of a prolonged weakness in demand for Refresco's bottling services across Europe or tighter margins if Refresco fails to adjust its pricing and product structure to an unexpected hike in raw material prices. We would consider a lower rating if the adjusted debt-to-EBITDA ratio rose to 4.0x and EBITDA interest coverage fell to 3.0x for a sustained period.

An upgrade of Refresco would most likely be the result of stronger credit ratios on the back of sustainable like-for-like growth and strengthening profitability. Specifically, we could raise the ratings if we see a sustainable improvement in the company's adjusted debt-to-EBITDA ratio to about 2.5x, supported by FOCF to debt comfortably above 15% in our forecasts.