OREANDA-NEWS. Fitch Ratings has downgraded Ideal Standard International SA's (Ideal Standard) Long-term Issuer Default Rating (IDR) to 'CC' from 'CCC' and affirmed its Short-term IDR at 'C'. A full list of rating actions is at the end of this commentary.

The downgrade reflects our view that Ideal Standard's capital structure is likely to be restructured as it remains unsustainably leveraged. Coupled with a slower-than-expected recovery in free cash flow (FCF) and bullet maturities in 2018, the group remains substantially exposed to refinancing risks. Although the gradual recovery of Ideal Standard's end-markets, its multi-year cost savings programme and the conversion of the financial structure to PIK support FCF generation and mitigate these risks, we expect cumulative FCF to be insufficient to materially reduce leverage before the group's debt maturity in 2018.

The ratings assume low single-digit revenue growth until 2018, driven by a recovery in European construction activity, and improving margins from higher fixed cost absorption and rationalisation programs started in 2013 and no cash payment of interest, due to the PIK capital structure. It also assumes no changes in the current capital structure.

KEY RATING DRIVERS
Unsustainable Leverage
The group's financial profile continues to constrain the ratings. Funds from operations (FFO) adjusted leverage will remain firmly in double digits until the group's senior secured notes become due in 2018. Although the improved operating performance and the conversion of the financial structure to PIK support FCF generation, we expect cumulative FCF will be insufficient to materially reduce leverage before the group's debt maturity in 2018. Refinancing risks remain material, despite the improving outlook for the operating environment.

Positive Trading Momentum
Sales grew by 8.3% in 1Q15 year-on-year, supported by growth of 4.5% and favourable foreign exchange impact (+3.9%). Revenues in the UK and Germany declined between 1%-2% in 1Q15, due to temporary issues such as merchant destocking and the launch of a customer-branded product in early 2014, while Italy grew around 2% from price gains. We expect strong growth in the UK, a gradual recovery in Italy and Germany and challenging conditions in France for the rest of the year. These four markets comprised 64% of the group's revenues in 1Q14.

Restructuring Results
The company-adjusted EBITDA margin (pre-restructuring and operational improvement costs) rose to 8% in 1Q15 from 2% from a year ago, primarily from improved pricing, capacity utilisation and the results of the group's multi-year restructuring and cost-optimisation programmes. Unadjusted EBITDA will improve as restructuring costs recede. However, we expect future cost-cutting measures to be limited by the group's liquidity and affordability as it is management's prudent policy to fund these with internally generated cash flow. Group EBITDA has historically lagged peers, partially due to a higher cost manufacturing footprint.

Leading Market Positions
Ideal Standard benefits from its leadership position in Europe, where it ranks first or second in various markets in ceramics and fittings. The group owns a comprehensive portfolio of strong brands covering a wide spectrum of market segments from entry level to luxury products.

Distressed Debt Exchange
Fitch downgraded Ideal Standard's IDR to 'RD' and subsequently upgraded it to 'CCC', following the exchange offer in 2014. The offer constituted a distressed debt exchange under Fitch's criteria because investors faced a reduction in terms and the offer was effectively coercive, given that the issuer required additional liquidity. Fitch recognises the positive impact that the successful exchange had on the group's liquidity and debt service, given EUR50m in new super senior AA notes and a PIK capital structure.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Ideal Standard include:
- Low single-digit revenue growth until 2018 driven by a recovery in European construction activity.
- Improved selling, general and administration expenses on sales ratio driven by higher fixed cost absorption and rationalisation programs started in 2013.
- Capex at around historical average of 3% of sales.
- PIK interest only.
- Negative FCF in the short-term.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-A significant improvement in margins, coupled with sustainable positive FCF generation and/or a material reduction in leverage leading to a manageable capital structure.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Imminent default or refinancing risks from a deterioration in liquidity, inability to service near-term interest or principal maturity or further debt restructuring measures.

LIQUIDITY
Liquidity is tight. Cash amounted to EUR37.6m at end-1Q15 and the group's EUR15m super senior RCF was fully drawn. This is sufficient to cover around EUR20m-EUR30m in intra-year working capital swings given no debt maturities until 2018 when the senior secured notes are due (assuming the roll-over of local credit facilities). The commitment of the super senior RCF was increased to EUR25m from EUR15m in 2Q15, more than offsetting the loss of liquidity from the expiry of the EUR4m Topco RCF in December 2014. However, material liquidity risk could arise, if local credit facilities are not rolled over or if the group generates substantial negative FCF. Neither scenario forms part of Fitch's rating case.

FULL LIST OF RATING ACTIONS

Long-term IDR: downgraded to 'CC' from 'CCC'
-Short-term IDR: affirmed at 'C'
- Super senior AA notes: downgraded to 'CCC'/'RR2' from 'B-'/'RR2'
- Senior secured A notes: downgraded to 'C'/'RR6' from 'CC'/'RR6'
- Senior secured B notes: downgraded to 'C'/'RR6' from 'CC'/'RR6'