OREANDA-NEWS. Fitch Ratings has downgraded Solvay SA's (Solvay) Long-term Issuer Default Rating (LT IDR) to 'BBB' from 'BBB+', and has removed it from Rating Watch Negative (RWN). The Outlook is Negative. Fitch has also assigned debt ratings to Solvay's newly issued senior unsecured bonds at 'BBB' and subordinated hybrid bonds at 'BB+'. A full list of rating actions is available at the end of this commentary.

The RWN removal follows the completion of Solvay's acquisition of US-based composites producer Cytec. The one-notch downgrade reflects Solvay's sustained deviation from the previously stated leverage guideline of funds from operations (FFO) adjusted net leverage of below 2x. Fitch forecasts leverage to peak at 3.8x at end-2015 following the closing of the acquisition, followed by a reduction to 2.9x in 2016 on Cytec's first full year consolidation.

We expect further de-leveraging towards 2.0x-2.5x from 2017 due to moderate volume growth and new projects' cash flow contributions. The deleveraging path is uncertain should a wider market downturn persist in 2016-2017, or if dividends, capex or M&A become more aggressive. This is reflected in the Negative Outlook.

The group's post-acquisition operational profile remains commensurate with a low 'A' rating category. The Cytec acquisition will moderately enhance Solvay's scale, geographical and product diversification with a greater focus on specialty chemicals. Simultaneously, Solvay will remain partly reliant on commoditised chemicals such as soda ash, acetow or polyamide, which contribute 35%-40% of the group's EBITDA.

KEY RATING DRIVERS
Leverage Hike on Cytec Acquisition
In July 2015 Solvay announced its plan to acquire Cytec (USD2bn turnover and 20% EBITDA margin) in a USD5.5bn transaction by end-2015. Solvay successfully raised the envisaged debt and equity funding and completed the acquisition in December 2015. The acquisition will result in leverage peaking at end-2015 before declining to 2.9x in 2016 as Cytec is consolidated and towards 2.0x-2.5x from 2017. Should Solvay receive a EUR0.2bn-EUR0.3bn cash inflow from its exit from polyvinylchloride (PVC) joint venture with INEOS in 2018, this could further reduce leverage by up to 0.15x.

Low 'A' Operational Profile
Solvay's continued efforts to increase its share of specialty chemicals in its portfolio, as recently evidenced by the Cytec acquisition and selected divestures, should lead to this segment generating 60%-65% of the company's cash flows. However, Solvay remains reliant on its cost-competitive commodity chemicals operations at 35%-40%. Coupled with strong geographical and end-market diversification, we view Solvay's operational profile as being consistent with a low 'A' rating category.

We expect the Cytec acquisition will contribute EUR2bn sales with nearly 20% EBITDAR margin to Solvay's earnings. Cytec's focus on US automotive and aerospace composites will moderately increase Solvay's sales in North America and will make Solvay's diversification across end-markets more balanced.

Diversification Mitigates Market Pressure
Weaker oil and commodity markets moderately affected Solvay's 9M15 performance with Novecare's oil and gas business and chlorovinyls being the hardest hit. However, well-balanced end-market and product mix resulted in a modest 1% total volume drop, flat pricing and 5% positive currency effects in 3Q15 compared with 3Q14.

Our prudent assumptions for 2016 include USD55/bl Brent oil pricing, a decelerating Chinese market and a low-single digit soda ash price correction. Next year results will also be slightly supported by the full-year impact of a stronger US dollar. From 2016 we expect volumes to recover broadly in line with regional GDP trends while portfolio-weighted pricing is likely to be marginally (less than 1%) negative.

We expect 2015 EBITDA margin to be slightly under 18% (2014: 16.4%) in 2015-2016, aided by positive FX effects, before improving to 18.3% in 2017 on synergies with Cytec and the contribution of the newly launched projects.

Reduced Exposure to PVC
Solvay divested its PVC assets across the globe and selectively contributed European PVC plants to its joint venture with Ineos. After Solvay exits the JV with Ineos in 2018, the group's exposure to the commoditised PVC segment will minimise in line with its strategy to focus on specialty and value-added chemicals. We expect that the cash inflow proceeds from Solvay's exit from its PVC JV to amount to EUR0.2bn - EUR0.3bn, which will allow Solvay to deleverage further or fund a similar-scale acquisition without weakening its business profile.

Pension Liabilities Weigh on Metrics
Recurring cash outflows associated with material pension liabilities weigh on Solvay's FFO-based metrics, which compare unfavourably with those of similarly-rated peers. The 3Q15 pension funding gap was down at EUR2.7bn, from EUR3bn at end-2014, but still up from EUR2.5bn at end-2013. The deficit remains highly sensitive to future discount rate variations. In line with Fitch's methodology, our treatment of these obligations focuses on their cash impact. Our base case conservatively assumes annual cash pension contributions at a percentage of sales similar to the 2014 level.

EUR1bn Hybrid Issuance
Fitch applies its 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Analysis' methodology to Solvay's subordinated hybrid bonds, and applies a 50% equity credit to the recently placed EUR1bn outstanding hybrid bonds. The rating assigned to the notes is two notches below Solvay's 'BBB' LT IDR, reflecting the notes' higher loss severity and risk of non-performance relative to senior obligations. The notes qualify for 50% equity credit as they meet Fitch's criteria with regard to subordination, remaining effective maturity of at least five years, full discretion to defer coupons and the lack of events of default.

With the exception of the EUR500m hybrid bond due in 2104, Fitch deems the effective maturity of all other outstanding hybrid issues, according to Fitch's hybrid criteria, at the dates of the respective call when coupon step-ups commence and in the absence of replacement language (which is 2026 and 2029 for the latest issued hybrids). The 50% equity credit will therefore apply until 2021 and 2024 as that is when the effective maturity of these issues will remain for at least five years. Fitch expects Solvay will repay the 2104 EUR500m hybrid issue on its first call date in 2016, which also means that we will no longer apply 50% equity credit to the EUR500m hybrid bonds.

The rating assigned to the existing and the recently placed USD1.6bn and EUR1.25bn senior unsecured bonds is 'BBB', which is in line with Solvay's LT IDR.

KEY ASSUMPTIONS
The assumptions for our rating case for the issuer include:
- 2015 sales to reflect 2% volume decline, with nearly neutral price impact, and aided by 7% currency impact;
- Low (less than 1%) price pressure to be offset by 2%-3% volume recovery in line with regional GDP trends in 2016-2017;
- Cytec to add EUR1.9bn to sales and EUR0.4bn to EBITDA margin, together with EUR0.5bn net debt brought to Solvay's balance;
- No further material M&A or divestiture activity, except for the potential to exit the PVC JV with Ineos with EUR0.7bn proceeds in 2018;
- Capex/sales to decline to 7.5% in 2018, from 9% in 2015, (7% in 2018 if new projects' sales are taken into account);
- Dividends per share flat in 2016 with low-single digit growth from 2017.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Clear deleveraging with FFO adjusted net leverage at or below 3x in 2016 and around or below 2.5x from 2017, while maintaining EBITDAR margin at above 15%, which would lead to the Outlook being revised to Stable
-Deleveraging with FFO adjusted net leverage maintained at 2x, and EBITDAR margin sustained above 15%, which would lead to an upgrade

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Prolonged market pressure, aggressive capex, shareholder distributions or M&A translating into EBITDAR margins below 12% or leverage materially above 2.5x from 2017.

LIQUIDITY
Solvay's end-3Q15 liquidity was robust with EUR1.1bn cash and equivalents and EUR2.4bn committed long-term credit lines comfortably covering its EUR1.2bn short-term debt. Solvay's EUR5.3bn Cytec acquisition in 4Q15 is additionally covered by the EUR2.25bn, EUR1bn and USD1.6bn bond issues as well as up to a EUR1.5bn rights issue. We expect Solvay's FCF to remain neutral in both 2015 and 2016, contributing to a solid liquidity profile.

The full list of Fitch's rating actions is as follows:

Solvay SA
- LT IDR downgraded to 'BBB' from 'BBB+'; RWN removed; Outlook Negative
- Long-term senior unsecured rating downgraded to 'BBB' from 'BBB+'; RWN removed
- Short-term IDR downgraded to 'F3' from 'F2'; RWN removed
- EUR1bn floating rate, EUR750m 1.625% and EUR500m 2.75% senior unsecured bond ratings assigned at 'BBB'

Solvay Finance (America) LLC
- USD800m 3.4% and USD800m 4.45% senior unsecured bond ratings assigned at 'BBB'

Solvay Finance
- EUR500m 5.118% and EUR500m 5.869% subordinated hybrid bond ratings assigned at 'BB+'.
- EUR500m 6.375%, EUR700m 4.199% and EUR500m 5.425% subordinated hybrid bonds' ratings downgraded to 'BB+' from 'BBB-'; RWN removed