OREANDA-NEWS. Fitch Ratings has maintained Compagnie de Saint-Gobain's (Saint-Gobain) Long-term Issuer Default Rating (IDR) and senior unsecured rating of 'BBB' and Short-term IDR of 'F2' on Rating Watch Negative (RWN).

The RWN continues to reflect the transaction risk around Saint-Gobain's acquisition of a 16% economic interest and 52% of voting rights in Sika. Completion of the acquisition would result in higher leverage than Fitch considers commensurate with the current ratings and would delay the group's de-leveraging profile. Fitch would not consolidate Sika, but adjust Saint-Gobain's credit metrics to reflect its 16% economic interest in Sika, accounting for the proportion of dividends attributable to Saint-Gobain as funds from operations (FFO). The resolution of the RWN is predicated on receiving final confirmation of the acquisition and removal of outstanding transaction risks. The RWN could also be resolved if Saint-Gobain's operating margins and credit metrics are expected to be in line with the ratings, despite the Sika acquisition. This would require stronger de-leveraging than currently anticipated in Fitch's ratings case post Sika acquisition.

The ratings reflect Saint-Gobain's strong business profile as a global leader in the manufacturing and distribution of higher value-added building products as well as its exposure to other end-markets for its flat glass products, in particular the car industry. The group has one of the most product and geographically diverse business models in Fitch's rated universe of building products and materials companies. This has benefited margin consistency over the past years. We expect higher earnings volatility, following the disposal of its stability-enhancing packaging business, Verallia. This is mitigated in part by the group's unwavering efforts to cut costs and reduce working capital and capex.

The affirmation of the Short-term rating reflects the group's strong internal liquidity position, which is commensurate with a 'F2' rating.

KEY RATING DRIVERS
Sika Delay Credit Positive
The delay of the CHF2.75bn (EUR2.3bn) acquisition due to opposition from Sika shareholders, board and management is neutral to positive for the ratings. Credit metrics benefit from another year of positive cash flow whilst the completion of the Verallia sale has removed transaction risks and uncertainty around the funding of Sika. Meanwhile legal battles are being fought by the Burkard family, with little expense or management attention tied up in the case.

The purchase agreement is binding only to the extent the family's voting rights and control is upheld. Conversely, the group also has an option to extend its agreement beyond 1H16 should the legal case persist.

Major Acquisition Hurdles Removed
The acquisition process has reached major milestones including the Swiss Federal Administrative Court's final ruling, which confirmed that Saint-Gobain does not have to launch a mandatory offer for the remaining Sika shares and the unconditional authorisation for the merger by all antitrust authorities, including the EU, US, Switzerland and China. A first instance decision by the Zug cantonal court is expected in 1H16 on whether the voting rights of the selling Burkard family are limited, but appeals up to the Federal Supreme Court could delay the process further.

Synergy Potentials
Management plans to reap EUR180m in annual synergies in 2019 from purchase, overhead and capex savings and additional sales from cross-selling of the two companies' complementary products. Around EUR110m of these synergies are expected to be at the Saint-Gobain level. In addition, Saint-Gobain's business profile will partially benefit from Sika's exposure to high-growth emerging markets, particularly in Asia, and higher-margin, value-added product portfolio compared with the group. However, given that Saint Gobain's economic interest in Sika would only be 16%, Fitch views these benefits as limited.

Lacklustre Recovery
We forecast low single digit growth and flat to modestly improving margins in 2015, excluding the impact of the Verallia sale. Consolidated sales for the year to date to 3Q15 (YTD 3Q15) increased by 3.9%, but like-for-like growth was only 0.4% (excluding FX effect). We expect a healthy recovery in the flat glass division, which has benefited from past cost-cutting programmes and the improving auto demand in Europe. However, we expect difficult construction markets in France to continue to weigh on group operating performance, although leading indicators show initial signs of stabilisation.

Structural Cost Cuts
We consider Saint-Gobain's continued cost-cutting efforts as credit positive. Earnings will be supported by the roll-out of additional cost savings of EUR360m in 2015 compared with 2014, of which EUR190m have already been achieved in 1H15. The group will have taken out EUR4bn of costs by-end 2015, or approximately 10% of the cost base at 2007. Associated restructuring expenses contributed to depress earnings over the past years and have averaged around 0.65% of sales.

We consider cost cuts partly structural, as the group reduced headcount since the peak in 2008 in line with the decline in volumes over the same period. Saint-Gobain also reduced flat glass production by 25% in Europe and energy usage by 11% since 2010.

Continued Capex and WC Control
Fitch considers credit positive management's guidance to reduce capex to EUR1.4bn in 2015 in response to the lacklustre operating environment. This results in capex (including intangibles) of around 3.8% revenues and is a solid reduction from levels of around 4.8% in 2011. We forecast moderate increases of capex over the next two years, based on around EUR1bn in maintenance and around EUR500m in expansion capex. In addition, working capital control continues to support cash generation and has reached a 10-year low of 40.8 days at end-1H15, 19 days fewer than 10 years ago.

Share Buy-Back
We consider credit negative the group's share buy-back programme, which more than offset shares issued this year, effectively cancelling the benefits of the group's scrip dividend. However, the increase in dividend paid in cash from 2014 is not material considering Saint-Gobain's level of debt.

Leading Market Position
Saint-Gobain is a world leader in the manufacturing and distribution of more sophisticated building products and high performance materials. Saint-Gobain's focus on higher value-added products, strong branding and growing demand for energy-efficiency, the group has more stable margins than many of its peers.

Well Diversified By Markets and Products
Saint-Gobain's product diversification contributes to the group's margin stability. Its innovative materials business serving among others automotive, aerospace and textile end-markets, which follow a different cycle than its construction products. In addition, the group generates 43% of its revenues from the renovation demand, which is less cyclical than the new-build demand, and 8% of revenues from infrastructure demand, which can be counter-cyclical. The group is also geographically well diversified, albeit with some exposure to France, which contributed 25% to 1H15 revenues. The remainder comprised Western Europe (42%), Asia and emerging markets (20%) and North America (14%).

KEY ASSUMPTIONS
- Flat organic growth in 2015, single digit organic growth over 2016-2018.
- Fitch calculated operating EBIT margins trending toward 6% by 2018.
- Restructuring costs of EUR200m on average over 2015-2018.
- Cash pension contributions of EUR200m each year.
- Average capex intensity of 3.8% over 2015-2018.
- Dividends fully paid in cash.

RATING SENSITIVITIES
Fitch will adjust FFO net leverage calculations for Saint-Gobain by deconsolidating the planned Sika acquisition and adding back the dividend proceeds to FFO. We continue to adjust metrics to account for EUR1bn of cash that we view as not readily available for debt repayment, as it is needed for operational working capital. Fitch also continues to adjust reported operating income and EBITDA by including restructuring costs (EUR252m in 2014), provisions related to asbestos claims (EUR90m) and removing the share in net income of business associates (EUR46m).

Positive: Future developments that may, individually or collectively, lead to the removal of the RWN include:
- Successful removal of the execution risk around the Sika acquisition.
- Improved organic operating performance and potential synergies from the Sika acquisition, resulting in EBITDA margins above 9.5% and positive FCF margin.
- FFO adjusted net leverage below 3.5x on a sustained basis.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Deterioration of operating performance measures.
-Inability to maintain a positive free cash flow margin.
-FFO adjusted net leverage above 3.5x on a sustained basis.

LIQUIDITY
Liquidity amounted to EUR8.2bn at end-1H15, comprising EUR4.2bn of unadjusted cash and EUR4bn of undrawn syndicated credit facilities. This is sufficient to cover EUR3.7bn of debt maturities over the next 12 months.