Fitch Ratings has upgraded the ratings of Owens Corning (NYSE: OC), including the company's Long-Term (LT) Issuer Default Rating (IDR) to 'BBB' from 'BBB-'.
The Rating Outlook is Stable.
The upgrade to 'BBB' reflects Fitch's expectation that Owens Corning's total debt to operating EBITDA will remain considerably below 2.5x in the intermediate-term, which is Fitch's positive rating sensitivity at the 'BBB-' level. Fitch's expectation is supported by the company's efforts to strengthen its balance sheet by reducing debt and allocating capital conservatively following the onset of the coronavirus pandemic in an effort to maintain strong credit metrics and preserve financial flexibility. Owens Corning's strong performance in 2H20 and 2021 as evidenced by outsized growth and improved profitability also demonstrate credit strength.
Improved Credit Metrics: Owens Corning's credit metrics are strong for the 'BBB' rating, with total debt to operating EBITDA of 1.5x at YE21. Fitch forecasts leverage to remain below or at the lower end of the company's 2.0x-3.0x target range in the near to intermediate term despite Fitch contemplating higher cash outflows related to increased dividend payments, elevated share repurchase activity, and potential bolt-on acquisitions. While the company may at times temporarily exceed the upper range of its leverage target during construction downturns or to execute strategic acquisitions, Fitch expects it will delever the balance sheet within a reasonable time frame.
Stable Demand Environment: Fitch forecasts a relatively stable operating environment for Owens Corning in the near term. Fitch expects revenues to grow 4%-5% in 2022 as higher prices are slightly offset by modest volume declines. Fitch contends that the pandemic caused some replacement and remodeling-driven demand to be pulled forward, which, in addition to improved channel inventory levels, could pressure volumes.
Fitch forecasts EBITDA margins to decline to around 22% in 2022 from 23% in 2021 from worsening raw material and energy inflation, and a stabilizing pricing environment given strong pricing realized over the past year. Given the company's limited exposure to Russia, Fitch expects that the impact of the ongoing war will be limited to margin pressure from higher energy costs.
Fitch forecasts revenues to decline modestly in 2023, which assumes softening demand in residential end-markets, partially offset by improvement in nonresidential construction markets. Fitch expects operating EBITDA margins to situate around 20% beyond 2022, supporting strong FCF generation and a robust liquidity position in the intermediate term. However, worsening inflation in a rapidly-deteriorating demand environment could lead to greater margin compression than Fitch's forecast. Nevertheless, the company has sufficient rating headroom relative to Fitch's leverage negative sensitivity at the 'BBB' IDR.
Leading Market Position: Owens Corning's roofing business is the second largest producer of asphalt roofing shingles in the United States, the largest producer of residential fiberglass insulation in North America, and a leader in technical insulation. Within its composites segment, the company holds the top position in glass non-wovens and the number two position in the global glass fiber market.
Fitch believes that strong market share positions in core markets leads to higher and more stable operating margins over time. Additionally, the diversity of the company's geographic presence, end-market exposure, and distribution channels are credit positives relative to more U.S. centric building products peers that have concentrated exposure to particular end-markets or distribution channels.
Consistent FCF Generation: The company has demonstrated its ability to generate strong FCF in recent years, with Fitch-measured FCF margins (after common dividends) over 11% in 2021, up slightly from 10% in 2020. Fitch expects FCF margins will decline modestly in 2022 as EBITDA margins take a step back and the company increases capital investments. Fitch expects Owens Corning's FCF margins will stabilize around 8%-9% in the intermediate term, with fluctuations caused by volatile raw material and energy costs.
Strong Financial Flexibility: Owens Corning had just under $1.0 billion of cash and equivalents on its balance sheet as of Dec. 31, 2021, as well as close to $1.1 billion of combined availability on its revolving credit facility and accounts receivable securitization facility. The company's strong FCF generation and strong liquidity position provide flexibility to execute its capital allocation strategy.
Following the onset of the pandemic, the company took a conservative approach to its capital allocation strategy in order to preserve financial flexibility, including reducing capex and pausing share repurchases. Owens Corning resumed share repurchases in 4Q20 and repurchased $570 million of stock in 2021. Fitch expects the company will continue to apply FCF and excess cash toward share repurchases in 2022, particularly as its debt to EBITDA remains below its stated 2.0x-3.0x leverage target and available liquidity greatly exceeds the operating needs of the business.
Growth Strategy: Fitch expects Owens Corning to continue to make acquisitions consistent with management's strategy of acquiring businesses with stable and attractive margins that provide synergy opportunities. Management has shown its willingness to opportunistically pursue a more aggressive growth strategy and consequently higher leverage levels, as demonstrated by acquisitions in the company's recent past, but Fitch expects the company will allocate excess FCF to debt reduction when leverage exceeds 3.0x.
Owens Corning's ratings reflect the company's leading market positions in all of its major businesses, strong brand recognition, and product, end-market, and geographic diversity. Risk factors include the cyclicality of the company's end-markets, exposure to volatile raw material costs, and its, at times, aggressive capital allocation strategy. Owens Corning's low leverage relative to its rating, in combination with its strong FCF generation, position the company well to maintain a relatively strong credit profile for its 'BBB' rating, even if the operating environment were to weaken.
Owens Corning's leverage metrics, including total debt/operating EBITDA of 1.5x are in-line with other low-investment grade building products peers, including Masco Corporation (MAS; BBB/Stable) and James Hardie Industries plc (JHX; BBB-/Stable), and are slightly stronger than Fortune Brands Home & Security (FBHS; BBB/Stable). Owens Corning has similar revenues compared with MAS and FBHS, which are all larger than JHX. The companies have comparable EBITDA margins, though Owens Corning has relatively more geographic and end-market diversification.
Total revenues grow about 5% in 2022 and decline around 3% in 2023;
Operating EBITDA margins just under 22% in 2022 and around 20% in 2023;
FCF margins around 8.5%-9.5% in 2022 and 2023;
FCF is used for share repurchases and bolt-on acquisitions;
Total debt to operating EBITDA to be below 2.0x in 2022 and 2023.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch's expectation that total debt to operating EBITDA will be consistently at or below 2.0x;
Management lowers its leverage target while remaining disciplined in its capital allocation strategy;
The company maintains a healthy liquidity position.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Fitch's expectation that total debt to operating EBITDA will sustain above 2.8x or net debt to operating EBITDA will sustain above 2.5x as a result of lower profitability, shareholder friendly activities, or a large debt-financed acquisition;
Meaningful and continued loss of market share and/or sustained inflation in raw material costs leading to EBITDA margins below 15%;
Operating EBITDA/interest paid falling below 6.0x.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Robust Liquidity Position: Owens Corning has a robust liquidity position, with $959 million of cash on the balance sheet as of Dec. 31, 2021. The company also had $796 million of borrowing availability under its $800 million unsecured revolving credit facility which matures in July 2026, and $279 million of availability on its $280 million accounts receivable securitization facility (maturing in April 2024). Owens Corning has no debt maturities until $400 million of senior notes come due in December 2024, with the majority of its debt maturing in 2029 or beyond.
Owens Corning is a global leader in engineered materials for its roofing, insulation, and fiberglass composites businesses.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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Fitch Affirms The Co-operative Bank at 'B+'; Outlook Stable
Fri 25 Mar, 2022 - 10:45 am ET
Fitch Ratings - London - 25 Mar 2022: Fitch Ratings has affirmed The Co-operative Bank plc's Long-Term Issuer Default Rating (IDR) at 'B+', with a Stable Outlook and the Short-Term IDR at 'B'. The bank's Viability Rating (VR) has been affirmed at 'b'.
Fitch has withdrawn the bank's Support Rating of '5' and Support Rating Floor of 'No Floor' as they are no longer relevant to Fitch's coverage following the implementation of its updated Criteria in November 2021. In line with the updated criteria, we have assigned The Co-operative Bank a Government Support Rating (GSR) of 'no support' (ns).
The Co-operative Bank's VR is below the 'bb' implied VR as we consider the bank's capitalisation and leverage (scored at 'b') to be weak, and this has a strong impact on our overall view of the bank's credit profile. The VR also reflects the bank's resilient franchise, healthy asset quality and improved profitability prospects. We consider its business model remains vulnerable to external pressures given strong competition in UK mortgage lending.
The Co-operative Bank's Long-Term IDR is one notch above its VR because we believe that there are sufficient resolution funds issued by The Co-operative Bank Finance plc, the bank's intermediate holding company (not rated), which afford additional protection to the bank's external senior creditors, in case of its failure.
Resilient Franchise: The bank's ethical focus has helped it to attract and retain customers, building resilience in its franchise. However, its business continues to face uncertainty, given its limited scale and lack of diversification. High costs continue to pose a challenge and put it at a disadvantage compared with other mortgage lending peers. The bank was successful in growing its loan book in 2021, taking advantage of wider mortgage margins and government-backed SME loan schemes, but its market share remains small, limiting its pricing power.
Healthy Asset Quality: Asset quality is healthy, with low arrears and moderate mortgage loan-to-value ratios. Government support measures for the housing market and the furlough scheme have supported loan health, with the bank reporting an impaired loan ratio of 0.3% at end-2021 (0.7% when including purchased originated credit-impaired loans, which are not all Stage 3). Given the low risk nature of its loans, we believe that loan deterioration through a downturn will be manageable, with an average four-year impaired loan ratio remaining below 2%.
Profitable from 2021: The Co-operative Bank became profitable in 2021 after nine years of losses thanks to its restructuring, strong business volumes combined with wider spreads in the mortgage market, significantly lower funding costs, and one-off items including rebates and tax credits. However, structural profitability remains weak, and is vulnerable to competitive pressures on asset margins, the bank's capacity to grow business and rising funding costs, including interest on additional debt buffers to be built from 2022. Nevertheless, we believe the bank is now better positioned over the medium term, supported by rising interest rates, and reduced operating costs.
Weak Capitalisation: The bank's common equity Tier 1 (CET1) ratio of 20.2% at end-2021 reflects the low risk weights assigned to mortgage loans under the bank's internal ratings-based approach and is due to fall to about 17% by end-2022 as a result of incoming regulatory changes. The bank's UK leverage ratio of 3.8% is due to fall to 3.6% at end-2022 and remains a constraint on growth. The Co-operative Bank is not bound by a minimum regulatory leverage requirement, but we believe the regulators would expect it to operate with at least 3.25%. The bank does not meet its PRA buffer but meets interim minimum requirement for own funds and eligible liabilities (MREL).
Resilient Customer Funding: The bank is predominantly retail-funded, with a resilient core deposit base. Access to wholesale markets is limited and largely consists of the recently issued MREL-eligible debt, Tier 2 debt and the Bank of England's Term Funding Scheme (TFSME) drawings for SMEs. Liquidity is healthy with large holdings of cash at the Bank of England boosted by the recent TFSME drawing, which raised its liquidity coverage ratio to 241% at end-2021.
No Support: The GSR reflects Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities if The Co-operative Bank becomes non-viable, in light of the legislation in place that is likely to require senior creditors to participate in losses for resolving the bank.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The ratings could be downgraded if The Co-operative Bank's CET1 ratio falls towards 16% or if its UK leverage ratio falls towards 3.25%, with no clear actions to reverse the trend. This would likely be caused by faster than planned growth or an unexpected return to losses.
The Long-Term IDR is also sensitive to the bank being able to build up its end-state regulatory resolution buffer requirements as communicated by the Bank of England, which includes qualifying junior debt and internal subordinated debt down-streamed from its intermediate holding company, The Co-operative Bank Finance plc. The Long-Term IDR could be downgraded to the same level as the VR if the bank is no longer required or able to meet end-state MREL regulatory requirements.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade would require the bank to sustain a longer record of improved structural profitability, and to demonstrate its ability to generate sufficient internal capital to allow it to grow and build up the scale it requires to compete efficiently with peers, while maintaining healthy buffers above minimum capital requirements. Upside potential will also be contingent on the bank being able to absorb the costs of issuing MREL-eligible debt to meet end-state requirements.
The VR has been assigned below the implied VR due to the following adjustment reason: Weakest Link - Capitalisation and Leverage (negative)
The Operating Environment score has been assigned in line with the implied score. The Sovereign Rating was identified as a relevant negative factor in our assignment
The Business Profile score has been assigned below the implied score due to the following adjustment reason: Business Model (negative), Market Position (negative)
The Asset Quality score has been assigned below the implied score due to the following adjustment reasons: Underwriting Standards and Growth (negative), Concentration (negative)
The Capitalisation and Leverage score has been assigned below the implied score due to the following adjustment reasons: Leverage and Risk-Weight Calculation (negative), Capital Flexibility and Ordinary Support (negative)
The Funding and Liquidity score has been assigned below the implied score due to the following adjustment reason: Non-Deposit Funding (negative)
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
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