OREANDA-NEWS. Fitch Ratings has downgraded France-based SGD Group SAS's (SGD Pharma) Long-term Issuer Default Rating (IDR) to 'B-' from 'B' and the senior secured ratings to 'B-'/'RR4' from 'B'/'RR4'. The Outlook is Stable.

The downgrade reflects SGD's weakened financial profile, even though operating performance has been stable and in line with expectations. The group's deleveraging has been delayed by EUR10m in cost overruns at its St. Quentin plant and higher-than-expected working capital requirements from the demerger with SGD perfumery. In addition, Fitch includes fully in its debt calculation a EUR28m vendor note that was used to finance the group's acquisition of green-field glass manufacturer Cogent. As a result, SGD Pharma's credit metrics are more commensurate with the 'B-' rating over a four-year rating horizon. Fitch forecasts funds from operations (FFO) adjusted gross leverage in excess of 7.0x at end-2015, before falling towards 6.5x over the next four years.

The ratings are based solely on SGD's pharma business and exclude the perfumery business, which is being demerged from the group. The ratings are also based on our assumption that SGD Pharma will continue to pay for the operational costs of the perfumery business until separation is complete and that the shareholder, Oaktree Capital, will provide credit support for any indemnity.

KEY RATING DRIVERS

Slower Deleveraging
SGD Pharma's deleveraging was slower than expected in 2014, due to higher-than-expected working capital requirements, driven by inventory building and the discontinuation of factoring. As capex has been delayed into 2015, we expect free cash flow (FCF) to remain negative only for this year and FFO adjusted gross leverage to peak at end-2015, before declining towards 6.5x over the forecast horizon. Fitch expects the group to be FCF-positive from 2016, when the separation of its perfumery and pharma operations is complete and capex returns to normalised levels.

Cogent Acquisition
SGD Pharma's acquisition of the green-field glass manufacturer provides the group with additional capacity to serve the global market for Type I glass that is suffering from undersupply, access to low cost production and expansion into tubular converted glass that management has identified as an attractive area of expansion. It is a further logical extension to the historical cooperation between the two companies.

Operating Performance as Expected
Current trading has been broadly in line with Fitch's expectations. We continue to forecast low single-digit growth over the coming years and EBITDA margins in the mid-20s. The moulded glass packaging market has been growing at healthy rates of 4% since the 2009 recession. We expect long-term favourable demand growth for pharma packaging, driven by global growth in population, life expectancy, chronic diseases and by fast-growing demand for healthcare and medicines in emerging markets.

Sound Business Profile
SGD Pharma's business profile is commensurate with the 'B' rating category. The limited scale of its operations and focus on the pharmaceutical glass market are mitigated by a range of therapeutic end-markets served by its products. Customer concentration is limited, eliminating dependence on the success of a single drug, format or customer.

Strong Market Positions
SGD Pharma has a strong market position, particularly in the profitable type I glass market, where it holds a 30% share globally. The market for this type of glass is highly concentrated, with the top-three players supplying 80% of the market. In its core western European markets (63% of revenues) the group is the undisputed leader in type II and III glass markets with shares of 55% and 33%, respectively.

High Barriers to Entry
Profitability is protected in the short- to medium-term by high entry barriers provided by SGD Pharma's technological leadership, the large investments required to set up new production and high switching costs for customers, including high regulatory requirements and the reputational risks associated with product quality issues. For customers, switching suppliers is therefore often not economical, given that the price of packaging is small compared with the price of the final product. It amounts to up to 3% for type I glass and up to 5% for type II glass.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Successful completion of the demerger,
-FFO adjusted gross leverage below 6.0x,
-Positive FCF generation through the cycle.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-FFO adjusted gross leverage above 9.0x,
-Liquidity pressures from negative FCF.

LIQUIDITY

SGD Pharma's liquidity is adequate, consisting of EUR16m in cash and cash equivalents and EUR61m of undrawn committed facilities at end-2014. This is sufficient to cover negative FCF from large capex in 2015 and EUR10m in short-term debt maturing in the same year.

KEY ASSUMPTIONS:

Fitch's key assumptions within our rating case for the issuer include:
-Long-term revenue growth of 2.5%
-Stable to improving operating profit margins above 25%
-Normalised maintenance capex of around 10% of revenue, following the operational separation of the perfumery and pharma businesses.