OREANDA-NEWS. September 28, 2015. Fitch Ratings has affirmed Italy-based L'isolante K-Flex Spa's (K-Flex) Long-term Issuer Default Rating (IDR) at 'B' with Stable Outlook. Fitch has also affirmed the group's EUR100m senior unsecured notes at 'B+'/'RR3'.

The affirmation reflect the group's better than expected operating performance in 2014 and year-to-date 2015 and the successful execution of cost optimisation measures following the EUR100m bond issues last year. The ratings remain constrained to the 'B' rating category by K-Flex's limited scale and operational diversification. The group operates 11 production units and reports around EUR50m of EBITDA annually. It is also exposed to modest technological risks and key man risks from its dependence on key members of the founding family, who own, manage and support the group.

The bond is rated one level above K-Flex's IDR to reflect its above-average recovery rate (RR3), as a result of the group's fairly low leverage for its ratings. The instrument rating benefits from the lack of secured debt ahead of the bond, except for around EUR7m of receivables funding which Fitch would treat as prior-ranking debt in a recovery scenario. Any material secured debt raised above the notes in the capital structure could result in a downgrade of the instrument rating.

KEY RATING DRIVERS
Positive Operating Performance
K-Flex's operating performance was solid in the year ending December 2014. Group revenues grew by 7% in 2014, driven by Asia, Middle East and America. The EBITDA margin grew to 17.6% in 2014 from 16.2% a year earlier, supported by operating leverage and margin-accretive measures. Positive trading momentum continues in 1H15, with revenues up 9% and EBITDA up 7% year-on-year.

Continued Cost Cutting
The group's EUR100m bond issue in 2014 allowed cost-cutting measures to be successfully implemented. These include new product launches in higher margin technical sectors, procurement cost reductions from offering higher quantities and better payment terms to suppliers in exchange for lower prices and renegotiation of rent contracts. As a result, the company obtained margin uplifts with limited working capital absorption in 2014. Fitch views positively K-Flex's continued cost focus during times of healthy volume growth.

Supportive Long-Term Demand
Fitch expects the elastomeric foams segment, which is a niche in the technical insulation market, to be supportive over the next few years, driven by tighter safety and energy efficiency regulation. K-Flex's international reach will support its ability to capture the rising global demand. In addition, the group continues to explore new technological applications, focusing on high-margin technical applications.

Modest Leverage
The group's financial profile continues to be stronger than its 'B' rated peers. Funds from operations (FFO) adjusted net leverage is forecast at around 3.4x at end-15, with potential for further deleveraging over the rating horizon. Acquisitions of around EUR30m could be comfortably accommodated in the group's financial headroom and would be commensurate with the ratings, although this does not form part of Fitch's base rating case.

Dominance in Niche
K-Flex holds a dominant market share of around 35% globally in the growing niche market for elastomeric foam (a fairly small part of the insulation market), which is estimated by the company at around EUR1bn. It shares the concentrated market with only one key global competitor. This provides some barriers to entry.

Broad End-Market Range
Product concentration on elastomeric foam is mitigated by the range of applications and end-markets served by its products. Elastomeric insulation makes up 37% of group revenue. The remainder is generated by related applications ranging from cladding and jacketing to pipe supports and tapes, which serve diverse end-markets. Industrial and commercial, oil and gas, heating and plumbing, and air conditioning and refrigeration end-markets together account for around 65% of revenues.

International Footprint
The group is geographically well diversified. It maintains a global commercial presence in over 60 countries, with EMEA and Asia each representing around 30% and the Americas, and Russia and Poland, each with around 20%. We expect capex requirements to fall significantly to around 8% of revenues from its peak 16% in 2012, as management's international expansion strategy is essentially completed.

KEY ASSUMPTIONS
- Mid-single digit revenue growth.
- EBITDA margin in the mid- to high teen range.
- Moderate working capital absorption in line with the increase of business volumes and management's strategy to reduce procurement costs.
- No cash return to the shareholders in the next few years.
- Positive free cash flow generation.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Reduction of key man risks from its dependence on key members of the founding family, who own, manage and support the group.
- FFO adjusted gross leverage below 3.0x.
- FFO adjusted net leverage below 2.0x.
- EBITDA margin increasing towards 20% on a sustained basis.
- Positive FCF with FCF margin above 5%.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- EBITDA margins towards the mid-teens.
- FFO adjusted gross leverage above 5.0x.
- Negative free cash flow through the cycle.
- Liquidity and covenant issues.

LIQUIDITY
Following the bond issuance in 2014, the group had unrestricted cash of EUR38m (adjusted for EUR10m of cash required for working capital swings) at end-14, which is sufficient to fund opportunistic cost optimisation measures. In addition, the group benefits from EUR70m in undrawn credit facilities. Of this, EUR35m is committed and together with positive free cash flow generation, liquidity would be sufficient to cover maturities of short-term roll-over debt of EUR40m.