September 7, 2012 / 6:17 PM / 8 years ago

TEXT-S&P cuts Reynolds Group Holdings rating to 'B'

Overview 
     -- Debt leverage remains very aggressive at New Zealand-based packaging 
producer Reynolds Group Holdings Ltd., as operating performance and free cash 
generation has been below expectations. 
     -- We lowered our corporate credit rating on Reynolds and its 
subsidiaries to 'B' from 'B+'. We also lowered the issue-level ratings on the 
company.
     -- The stable outlook reflects expectations that earnings and debt 
reduction will be sufficient to support credit measures consistent with the 
lowered ratings. 

Rating Action

On Sept. 7, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on Reynolds Group Holdings Ltd. to 'B' from 'B+'. We also 
lowered the issue-level ratings on the company's senior secured debt to 'B+' 
from 'BB-', and lowered the issue level ratings on its unsecured debt to 
'CCC+' from 'B-'. The '2' and '6' recovery ratings, which remains unchanged, 
reflect our expectation for substantial (70% to 90%) recovery and negligible 
(0% to 10%) recovery, respectively, in the event of a payment default. The 
outlook is stable.

Rationale

The downgrades reflect Reynolds' still highly leveraged financial profile and 
lack of earnings growth and debt reduction to the extent we previously 
expected. The ratings on Reynolds reflect Standard & Poor's assessment of the 
company's business risk profile as "strong" and financial risk profile as 
"highly leveraged".

Reynolds is a market leading provider of food and beverage packaging owned by 
Rank Group, a New Zealand-based investment firm controlled by a single 
individual. The company has grown rapidly via debt-financed acquisitions 
during the past three years, including the acquisitions of Graham Packaging 
and Pactiv. We expect the company to continue to pursue aggressive growth 
policies that are likely to include small to moderate bolt-on acquisitions to 
expand its market positions, and additional steps to consolidate segments of 
packaging sector. Given the heavy annual interest cost burden of about $1.35 
billion, we believe the company would need to demonstrate its ability to 
generate free cash flows of about $500 million annually and its willingness to 
permanently reduce debt to improve credit measures to appropriate levels for 
the ratings in the next 12 months.  

The company is one of the world's leading and most-diversified consumer and 
foodservice packaging providers, with annual revenues of nearly $14 billion, 
pro forma for the September 2011 acquisition of Graham Packaging Holdings Co.  
for $4.5 billion. The prevalence of food-related products lends considerable 
stability to sales and operating results even in periods of economic weakness. 
EBITDA margins are attractive at 18% and among the highest in the industry. 
Given its high debt leverage, Reynolds is vulnerable to raw material cost 
swings, particularly in plastic resin and aluminum. It's also subject to 
seasonal working capital variations, with sales typically higher in the warmer 
months. Management has a good track record of achieving targeted cost 
reductions and acquisition-related synergies. However, lower sales volumes and 
ongoing operational issues in the Graham Packaging segment, as well as 
sluggish consumer spending patterns, have resulted in lower earnings than it 
previously expected for the first half of 2012.  

We believe Reynolds should be able to largely obtain the approximately $400 
million of targeted synergies and other cost reductions associated with both 
of these acquisitions and the smaller acquisition of Dopaco Inc. in May 2011. 
Synergy realization, together with modest earnings growth or debt reduction, 
should bring credit measures to appropriate levels so that total adjusted debt 
to EBITDA is about 6.5x. At June 30, 2012, we estimate total adjusted debt to 
be about $18.9 billion, including about $1.2 billion of tax-effected 
postretirement liabilities and capitalized operating leases. As of June 30, 
2012, we estimate total adjusted debt to trailing-12-month EBITDA at about 
7.3x pro forma for all recent acquisitions before unrealized synergies.

Liquidity

We view Reynolds' liquidity as "adequate" under our criteria because we expect 
cash sources to more than cover cash needs over the next two years. 

Our liquidity assessment reflects on the following factors and assumptions:
     -- Sources of liquidity over the next 12-24 months will exceed its uses 
by 1.2x or more;
     -- Net sources would be positive even with a 20% drop in EBITDA; and
     -- The company has good standing in the credit markets.

Anticipated uses of liquidity include:

     -- Annual debt maturities, including about $47 million of annual term 
loan amortization; 
     -- Capital spending of $650 million per year (of which a substantial 
portion is discretionary);
     -- Working capital fluctuations due to changes in raw material prices and 
seasonal requirements; and 
     -- Pension funding requirements, which we believe should not be onerous 
over the next couple of years but could increase significantly depending on 
investment performance and discount rates.

Reynolds had about $1.22 billion in cash and availability of about $129 
million under its $120 million and EUR80 million revolving credit facilities as 
of June 30, 2012. Reynolds used the net proceeds from the $1.2 billion notes 
issuance completed in February 2012 to primarily redeem the Graham Packaging 
and Pactiv notes. Besides the debt paydown, Reynolds has maintained remaining 
proceeds as cash on the balance sheet to bolster liquidity and for general 
corporate purposes. We expect Reynolds to maintain at least $500 million in 
readily accessible cash at all times. This is to compensate for its 
comparatively small revolving credit facilities, which we expect it to use 
primarily for letters of credit.

The company generated free cash flows of $20 million in the first six months 
of 2012. We expect significantly higher cash flow from operations in the 
second half of 2012 to support about $350 million of free cash generation in 
2012, which the company plans to primarily use to reduce debt. Under terms of 
the credit agreement, the company has a 50% cash flow sweep. 

We expect Reynolds to remain in compliance with the financial covenants, 
including a maximum senior secured leverage ratio (of 4x or below) and minimum 
interest coverage ratio. We expect limited headroom under the minimum interest 
coverage as the covenant steps up from 1.65x as of June 30, 2012, to 1.7x at 
March 31, 2013, and steps up further to 1.75x at March 31, 2014, and we would 
expect the company to take timely steps to obtain an amendment if necessary. 

Recovery analysis

For the complete recovery analysis, see our recovery report on Reynolds, to be 
published shortly on RatingsDirect. 

Outlook

The outlook is stable. We expect credit measures to strengthen to the 
appropriate 6.5x we consider consistent with the rating. We could lower the 
ratings if Reynolds does not consistently generate positive free operating 
cash flow, or if liquidity erodes significantly, or if it were in danger of 
violating financial covenants. We could also lower the ratings if the company 
undertakes another large, debt-financed acquisition, which causes debt 
leverage to increase significantly. 

For us to consider a downgrade, EBITDA margins would have to deteriorate to 
about 17% on sales declines of 5% or more, based on our view of the company's 
adjusted debt levels. This would result in debt leverage of 7.5x or more. Cash 
flow could weaken to less than we currently anticipate if deteriorating 
economic conditions cause a significant slowdown in consumer spending or the 
company experiences heightened competition in any of its businesses or if raw 
material prices rise so sharply that the company is unable to pass on its 
higher costs to customers. 

Reynolds' current very aggressive financial policies and high debt leverage 
make an upgrade unlikely at this time. If earnings growth and debt reduction 
improved credit measures such that total debt-to-EBITDA was 6x, and funds from 
operations-to-total adjusted debt was 10% on a sustained basis, we could 
consider an upgrade. This would require the company to both improve operating 
results in the current difficult operating environment and to pursue its 
growth objectives in a manner that does not stretch the balance sheet.  

Related Criteria And Research

     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- Key Credit Factors: Methodology And Assumptions On Risks In The 
Packaging Industry, Dec. 4, 2008

Ratings List
Downgraded; Outlook Revised 

Reynolds Group Holdings Ltd.
Pactiv Corp.
Beverage Packaging Holdings (Luxembourg) II S.A.
Beverage Packaging Holdings (Luxembourg) I S.A.
                                        To                 From
 Corporate Credit Rating                B/Stable/--        B+/Negative/--

Downgraded
                                        To                 From
Beverage Packaging Holdings (Luxembourg) II S.A.
 Senior Secured                         CCC+               B-
  Recovery rating                       6                  6
 Subordinated                           CCC+               B-
  Recovery rating                       6                  6

Pactiv Corp.
 Senior Secured                         B+                 BB-
  Recovery rating                       2                  2
 Senior Unsecured                       CCC+               B-
  Recovery rating                       6                  6

Reynolds Consumer Products Holdings Inc./Reynolds Group Holdings Inc.

 Senior Secured                         B+                 BB-
  Recovery rating                       2                  2

Reynolds Group Issuer (Luxembourg) S.A./Reynolds Group Issuer Inc.

 Senior Secured                         B+                 BB-
  Recovery rating                       2                  2
 Senior Unsecured                       CCC+               B-
  Recovery rating                       6                  6

Reynolds Group Issuer LLC
 Senior Secured                         B+                 BB-
  Recovery rating                       2                  2
 Senior Unsecured                       CCC+               B-
  Recovery rating                       6                  6

Sig Austria Holding GMBH/Sig Euro Holding AG & Co. KGAA
 Senior Secured                         B+                 BB-
  Recovery rating                       2                  2
 

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
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