Rating Methodology
July 2006
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Global Building Materials Industry
Summary
This rating methodology sets forth the key analytical factors that contribute to Moody’s ratings of companies in the
global building materials industry. Its primary goal is to help issuers, investors and other participants in the industry
understand how Moody’s assesses risk in building materials and to enable our constituents to be able to gauge a
company’s ratings. This methodology is not an exhaustive treatment of all factors reflected in Moody’s ratings, but it
should enable the reader to understand the key considerations and financial ratios used by Moody’s in the final rating
determination.
For purposes of this methodology, we have defined building materials producers as those companies involved in
the production of basic building materials, namely cement, concrete, aggregates, gypsum, bricks and roof tiles.
Although the universe consists of issuers of varying size and focused on different customer industries, rated issuers do
exhibit similar business fundamentals and face many common credit considerations. The fundamental business drivers
affecting building materials companies tend to be highly correlated to construction activity, which is itself often a
derivative of regional economic growth.
This methodology focuses on the key operational and financial aspects that Moody’s believes to be the critical
cornerstones of a company's performance and its ability to remain competitive and service its debt obligations.
There are five key factors that Moody’s uses to examine credit risk and assign ratings in the building materials
sector, with sub-factors that form important building blocks for many of the categories. These factors, which will be
closely examined in this report, are as follows:
1. Business Profile
2. Size and Stability
3. Cost Position and Profitability
4. Financial Management Strategy
5. Financial Strength
A number of other generic factors such as quality of management and corporate governance, although difficult to
quantify, can also have a meaningful impact on ratings assigned to building materials companies. However, these
factors, which are covered in the section “Other Considerations” are not deemed specific to the sector, but rather are
applied across the corporate finance franchise.
Highlights of this report include:
• An overview of the key risk factors for the global building materials industry
• A description of the rating methodology and the five primary factors (comprising 13 sub-factors) that we believe
drive credit quality in this sector
• Application of the rating framework to 12 representative building materials producers
• Discussion of “outliers” – companies whose rating for a specific factor differs significantly from what its actual
rating would otherwise imply
• An explanation of other rating considerations
• A summary of our results and their weightings
In an effort to promote transparency, we have also provided a detailed rating grid, which maps each key rating
factor, including sub-factors and financial metrics, to specific letter-ratings. The purpose of this rating grid is to
provide issuers, investors, and other participants with a reference tool when comparing credit profiles within the building materials sector. We would nonetheless caution that a company will not necessarily match exactly each letter-rating
dimension of the grid; the rating output of the grid will therefore be a balance of all the factors that have been identified. Further it must be recognized that ratings are prospective opinions on future relative credit risk. Event risk, e.g.
acquisitions that alter a firm’s capital structure and/or liquidity profile and, most importantly, expectations on forwardlooking performance and cash flows continue to be major influences on Moody’s ratings.
Basic Building Materials: Overview of the Global Rated Universe
For purposes of this methodology, we have defined building materials producers as those companies involved in the
production of basic building materials, namely cement, concrete, aggregates, gypsum, bricks and roof tiles.
Moody’s publicly rates 25 basic building materials companies globally with an aggregate of nearly $65 billion of
total debt.
2
Moody’s Rating Methodology
Global Building Materials Companies
As per June 2006
Moody’s LT
Rating
Company
Vulcan Material
Martin Marietta Materials
Rinker Group
Boral
CRH*
Hanson
Saint Gobain
Ciments Francais
Imerys
Lafarge**
Wienerberger
Cemex
KCC
Taiheiyo
USG
Dyckerhoff***
HeidelbergCement
Camargo Correa Cimentos
Texas Industries
St. Marys Cement
Headwaters
U.S. Concrete
Loma Negra
Ready Mixed Concrete
CP Cimento
A1
A3
A3
Baa1
Baa1
Baa1
Baa1
Baa2
Baa2
Baa2
Baa2
Baa3
Baa3
Baa3
Baa3
Ba1
Ba1
Ba3
Ba3
Ba3
B1
B1
B2
B2
Caa2
Outlook
Country
stable
stable
stable
stable
stable
stable
stable
stable
stable
negative
stable
stable
positive
stable
stable
positive
positive
stable
stable
stable
stable
stable
stable
stable
negative
USA
USA
Australia
Australia
Ireland
UK
France
France
France
France
Austria
Mexico
Korea
Japan
USA
Germany
Germany
Brazil
USA
Canada
USA
USA
Argentina
USA
Brazil
Revenues as per
Latest FY End
in US $ bn****
Gross Debt as
per Latest FY End
in US $ bn****
2.9
2.0
5.1
3.3
18.0
6.8
43.7
4.5
3.8
19.9
2.4
14.9
2.5
8.2
5.1
1.7
9.7
0.2
2.0
0.6
1.1
0.6
0.2
0.2
0.2
0.6
0.7
0.7
1.1
6.4
3.8
10.6
1.5
1.7
11.2
1.3
9.2
0.8
6.2
1.0
0.6
4.9
0.5
0.8
0.2
0.7
0.2
0.2
0.2
0.2
* incl. MMI Products
** incl. Lafarge North America and Blue Circle
*** incl. Lone Star
**** Note: Except otherwise stated as per 12/2005, exceptions are: Rinker 03/3006, Boral 06/2005, Taiheiyo 03/2005, Loma
Negra 08/2005, KCC 12/2004
Geographically,
• 36% of the rated issuers are based in Europe,
• 48% in the Americas, and
• 16% in Asia Pacific.
40% of the universe is rated below investment grade.
Rating Distribution
Number of Issuers
5
4
3
2
1
0
AaaAa3
A1
A2
A3
Baa1
Baa2
Baa3
Ba1
Ba2
Ba3
B1
B2
B3
Caa-C
Rating
Moody’s Rating Methodology
3
The global investment grade ratings are clustered in the mid-Baa range and the speculative grade ratings are
gathered around the B1 rating level.
The rating grids used for illustrative purposes in this methodology cover 12 of the rated building material companies, which were selected to represent a wide range of credit ratings, size, operating characteristics, and geographic
locations. The representative companies listed below comprise roughly $43 billion, or 65%, of the total debt of issuers
in the building materials industry rated by Moody’s.
Representative Sample of Building Materials Companies
As per June 2006
Company
Rinker Group
Martin Marietta Materials
Boral
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCement
Camargo Correa Cimentos
St. Marys Cement
U.S. Concrete
Moody’s
LT Rating
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
Outlook
stable
stable
stable
stable
negative
stable
stable
stable
positive
stable
stable
stable
Model Rating
A
Baa
Baa
A
Baa
Baa
Baa
Ba
Baa
Ba
Ba
B
Country
Australia
USA
Australia
Ireland
France
Austria
Mexico
Japan
Germany
Brazil
Canada
USA
Industry Challenges and Rating Drivers
Companies in the basic building materials industry share a number of key features that have an impact on their credit
profiles:
I. In general, building materials is a cyclical industry.
Cycles invariably follow the patterns of the building materials producers end markets – namely, the construction and infrastructure industries. However, these cycles are usually limited to regional, if not local, markets.
Price wars, as currently experienced in Brazil or in the recent past in Germany, can add to local economic
downturns. Companies that are diversified geographically and in terms of their products are usually expected to
weather regional downturns with the help of good performance in other regions. Therefore, Moody’s expects
geographically diversified building materials companies to typically generate more stable cash flows than those
that lack such diversification.
II. Building materials have a low value-to-weight ratio.
The low value-to-weight ratio prevents companies in this market from competing globally. For example, the
transport of hollow bricks is only considered economical if the distance is below 200 km (around 120 miles)
from the plant. Local production, a well-spread asset base and the application of a best practice approach are
keys for success. Pricing is therefore negotiated on a local rather than on a global basis. The shipment of
cement over large distances is only economical, although far less profitable if the plant is close to a sea port
where it can be loaded in large quantities.
III. Companies typically benefit from flexibility in their requirements of capital expenditure for maintaining their
production base, which allows them to adapt to changes in regional or market characteristics.
The technology to produce building materials is well established, notwithstanding the need to upgrade the
facilities following regulatory changes, such as the introduction of the CO2 emission trading scheme. Maintenance capex can be planned flexibly and is in the short to medium term generally lower than the depreciation
charge for the assets. In addition, general overhauls of single cement plants, which are most costly, can be
planned a long time ahead and the lifetime of a cement plant can span over a couple of decades without the need
for major investments. In the event of a downturn in specific markets, building materials companies can therefore offset lower operating cash flows with a reduction in capital expenditures.
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Moody’s Rating Methodology
IV. GDP growth is a primary driver of organic revenue growth, and construction and refurbishment activity in
particular regions or markets will therefore influence top-line growth rates.
GDP growth in the mature markets of Western Europe and North America is expected to be comparably low
and, as a result, companies in the industry will invariably seek growth through investments in emerging and
fast-growing markets or via further consolidation in established markets and through vertical integration. The
funding of external growth is therefore a key consideration when analyzing building materials companies.
V. Barriers to entry are often very high given the limited availability of raw materials, such as pits and quarries, and
the high initial cost of entering markets, e.g. building a plant in the case of the cement market and establishing
efficient distribution channels.
In mature countries, most of the rights and permits for raw materials have already been assigned. In addition,
the high cost of building production facilities, especially in the cement and brick markets, adds further barriers
to entry. In consolidated markets, it is also difficult for new market entrants to gain market share as established
players will adapt their strategies to defend market positions, which can in the short term impact all players in
the market, as noted in the Brazilian cement market since 2005.
The aggregates industry in mature markets is still highly fragmented, with many small companies operating
only a limited number of quarries in a specific region, thereby making it less difficult for companies to enter
new markets via smaller bolt-on acquisitions. Therefore, it is considered that there is still room for further
consolidation and expansion for the leading building materials companies. In contrast, the cement industry is
mostly consolidated, with only a few market participants operating. In cement, expansion of global players is
therefore expected to come from vertical integration or from an extension of geographic reach into emerging
markets, essentially through acquisitions.
VI. The production of building materials is energy-intensive. Increases in the cost of energy can have a material
impact on the performance of profitability and cash flow.
Energy constitutes a sizeable proportion of the operating costs of certain segments in the building materials
industry. Generally, producers of building materials hedge a large part of their energy bill; however, the maturity of hedging instruments, which have provided the companies with comparatively low energy prices, is
expected to have a negative impact going forward. In addition, companies are lowering energy bills by using
alternative fuels, such as used tires and waste.
VII.In addition, ongoing consolidation, liquid balance sheets and stable cash flows are likely to pose an increased risk
of large debt-financed acquisitions, e.g. Saint-Gobain’s takeover of BPB. Specific players are also likely to face
shareholder pressure to exploit cash sources, notably through share buybacks or increased dividend payments.
Key Issues Looking Into the Next Decade
Countries with high population growth will drive future development
Consumption of building materials is strongly affected by two factors: population growth and the economic
development of a country based upon its GDP per capita. The annual growth of the world population was 1.5%
between 1985 and 2005. The highest growth rate was recorded in Africa (+2.5%) and the lowest growth (-0.1%) was
recorded in Eastern Europe. In addition to having the highest rates of population growth, emerging markets and also
some areas in the United States (e.g. Florida, Texas, California) are characterized by strong growth in demand for all
sorts of building materials. Companies operating in these areas are considered to be in an advantageous position as
regards demand/supply and their ratings could therefore benefit from activities in these growth regions in the longer
term. Companies with no or only limited exposure to the high-growth areas may be faced with weaker cash flow
generation ability, potentially resulting in lower ratings over the longer term..
Sustainability of high energy prices
As the use of energy is a critical factor in the manufacturing process of building materials, such as cement, aggregates
or bricks, these will continue to play a major role for the companies involved in this sector. Sustained high energy
prices will put pressure on the company's margins over time in the absence of any pass-through. Reducing energy
consumption, managing energy prices via hedging instruments and successfully passing on increased input costs are
considered to be the key challenges in the coming years. A weaker economic environment, coupled with increasing
input prices, might lead to substantial pressure on margins because the companies might not be able to pass on the
increase in costs. Therefore cash flows would be weaker and as a consequence there would be pressure on the ratings as
well.
Moody’s Rating Methodology
5
China and India – High volumes, low prices, fragmented market
China, followed by India, is by far the largest building materials market in the world, accounting for roughly 44% of
global cement production. If cement consumption is taken as an indicator of the growth and potential of the building
materials industry, China will likely become an increasing factor in the global supply/demand characteristics of the
building materials industry. Moody’s recognizes that the Chinese market remains highly fragmented with over 5,200
independent cement manufacturers, each with an average annual capacity of only 200,000 tons and some inefficient
production technologies. Comparing it to the United States market, where the top 5 producers capture over an
estimated 60% of the market, China’s top 10 producers only account for 15% of total domestic production. Moody’s
also recognizes that China’s Economic Operation Department of the National Development and Reform Commission
is currently encouraging consolidation in the industry and aims to boost national cement output by 25% over the next
five years, as strong growth is expected to continue.
The fragmentation of the market currently leads to high price volatility and – on average – very low prices.
Coupled with high energy costs, this leads to very low margins.
Despite these challenging conditions, Moody’s expects global building materials companies to more actively
attempt to penetrate the Chinese market, and remains cautious about the global implications of potential excess capacity
in China following the 2008 Olympic Games.
Debt-financed industry consolidation
We expect continued consolidation in the industry, driven primarily by the compulsion to increase revenues at a rate in
excess of average GDP growth and to further consolidate fragmented markets, especially in the areas of concrete, aggregates, bricks and roof tiles. Moody’s anticipates that the trend of vertical integration by globally integrated building
materials companies will accelerate over the intermediate term. Event risk, particularly with regard to acquisitions, will
continue to be a rating consideration. In the methodology we capture this effect with the sales volatility figure: if a
dramatic increase in revenues results from aggressive external growth, this could indicate increased volatility and therefore a lower rating category may be warranted.
CO2 emission reduction
The greenhouse gas Emissions Trading Scheme (ETS) that came into operation at the beginning of 2005 was devised
to help developed countries achieve the emission reduction targets laid out in the Kyoto protocol. Emission certificates
have been allocated to the companies for free. The scheme covers a total of more than 12,000 installations in the EU’s
25 member states. The building materials sector has been identified in the first phase of ETS as one of the heaviest
emitters of carbon dioxide (which also include electricity generation, heat and steam production, mineral oil refineries,
coke ovens, iron and steel plants and factories manufacturing pulp and paper).
So far, building materials producers in general appear to have been allocated sufficient certificates to continue
production at current levels and are additionally able to sell small quantities of excess certificates.
The current scheme terminates in 2008, but the details of the new scheme have yet to be agreed. The availability
of emission certificates will most likely be reduced, and there is the possibility that the companies will have to pay for
the initial allocation of the certificates. It is therefore important for companies with activities in mature countries to
increasingly use alternative fuels, such as waste, old tires or pet coke.
6
Moody’s Rating Methodology
In the United States, although emission certificates are not applicable, emission levels remain relevant to capital
spending initiatives in the building materials industry, particularly to cement companies. The ability to secure permits
for additional capacity is principally linked to an issuer’s ability to reduce or maintain current emission levels in a given
region, typically by implementing technological improvements on aging equipment. As such, Moody’s does not envision notable amounts of additional cement capacity coming online in the United States after currently planned capital
spending projects are completed through 2008 – 2009. Any additional demand exceeding the production capacity is
expected to be met via imports from other parts of the world. Already today around 30% of the US’s cement consumption is imported.
In This Methodology
Moody’s approach to rating companies in the building materials industry incorporates the following steps:
1. IDENTIFICATION OF THE KEY RATING FACTORS
These are the key factors that Moody’s considers to be major drivers in determining a rating for a company in the
global building materials industry:
1 Business Profile
2 Size and Stability
3 Cost Position and Profitability
4 Financial Management Strategy
5 Financial Strength
Each of the five factors contains between two and three sub-factors, which comprise the components viewed as
most important in assessing the credit quality of building materials issuers. In total, the five categories include 13 subfactors. Any change in one or more of these factors is likely to influence the overall business and financial risk assessment incorporated in a rating. The factor may either be:
• Quantitative: Financial assessments that can be derived from publicly available data (e.g. operating margin,
revenues). The ten quantitative factors considered in this methodology are assigned a total weight of 80%.
or
• Qualitative: An assessment based on rankings estimated by Moody’s, or broader quantitative measures defined by
Moody’s in this methodology (e.g. market position, number of countries in which a company is active). 20% of the
overall weight is allocated over the three qualitative sub-factors.
In addition to the five major factors discussed in this report, Moody’s considers other qualitative factors which
either cannot be quantified or cannot be quantified in a meaningful manner. These factors, however, may represent
important and in some cases overriding considerations. These factors are explained in the “Other Considerations”
section.
2. MEASUREMENT OF THE FIVE KEY RATING FACTORS
Moody’s practice for measuring ratios is to use the past two or three years’ actual results along with Moody’s expectation for the next two or three years’ results, and to consider the average as well as the high and low points. This gives
us a view of a company’s ability to perform in both high- and low-price environments. For illustrative purposes in this
methodology, we have used five years of historical data only for each of the sample companies as a proxy for various
price environments that Moody’s would consider in ratings deliberations.
However, some of the companies covered in this methodology do not have a five-year history - namely, Rinker
(which was divested from CSR four years ago), Martin Marietta, St. Marys Concrete and US Concrete. We have
therefore used three- or four-year figures, as available.
Certain of the metrics we use (such as the volatility of Revenues, Operating Margin or Interest Coverage) are
based on a volatility measure covering the past five years’ results, while other measures (such as Debt to Book Capitalization) are taken at a fixed point in time, which is usually the most recent year-end for which the data is available.
Except where otherwise noted, financial figures used are adjusted based on Moody’s standard analytical adjustments1.
We identify throughout the report the basis of measurement for each metric.
1.
Please refer to Moody’s Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations Part I and II.
Moody’s Rating Methodology
7
Please note that for company-specific results listed in this publication we rely solely on public information,
whereas actual rating decisions will also incorporate non-public data as applicable.
3. MAPPING FACTORS TO THE RATING CATEGORIES
The methodology sets forth what Moody's believes to be appropriate ranges for broad rating categories from Aaa-Aa
to Caa-C for the sub-factors. The ranges represent, on average, our expectations for each rating category. After identifying the measurements and ranges for each factor, the outcomes for each of the 13 sub-factors are mapped to a
Moody’s rating category (i.e. Aaa, Aa, A, Baa, Ba, B and Caa).
4. DETERMINING THE FINAL RATING
To determine an overall rating, each of the 13 assigned sub-factor ratings is converted into a numeric value based on
the following scale:
Conversion of Sub-Factor Ratings Into Numeric Value
Based on
Rating Categories
Based on
Notches
Aaa-Aa
2
Aaa Aa1 Aa2 Aa3
1
2
3
4
A
6
A1
5
A2
6
Baa
9
Ba
12
B
15
A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3
7
8
9
10 11 12 13
B1
14
B2
15
Caa-C
19
B3 Caa1 Caa2 Caa3 Ca
16 17 18 19 20
C
21
At the sub-factor level, the lowest value is assigned to an implied Aaa-Aa rating, for which a 2 is assigned, while the
highest value is assigned to a Caa-C rating (19). In general, the numeric value for each rating category, such as the 6 for
the “A” category derives from the average of the numeric values applied for each notch within this rating category.
Each sub-factor’s numeric value is multiplied by an assigned weight (refer to the table below), and then summed. For
information purposes, the table below also shows sub-totals for the summation that show how much weight is given to
each broad rating category.
Factors
Sub-factors
Factor 1: Business Profile
Product Line Diversity
Geographic Diversity
Market Position
5.0%
10.0%
5.0%
20%
Factor 2: Size and Stability
Revenues
Revenue Stability
10.0%
10.0%
20%
Factor 3: Cost Position and Profitability Operating Margin
Operating Margin Volatility
ROAA
6.67%
6.67%
6.67%
20%
Factor 4: Management Strategy
Debt / Capitalization
Debt / EBITDA
10.0%
10.0%
20%
Factor 5: Financial Strength
EBIT / Interest
RCF / Net Debt
FCF / Gross Debt
6.67%
6.67%
6.67%
20%
100.0%
100%
Total
Weighting
Cumulative
Sub-Factor
Weighting
The total is then mapped to the table below, and an overall rating is assigned based on where the score falls in the
range. Since the composite rating indication is presented at the alpha-numeric rating level while sub-factor rating indications are presented at only the alpha level, the table shows outcome ranges for both presentation formats.
8
Moody’s Rating Methodology
Indicated Total Rating
Aaa
Aa1
Aa2
Aa3
A1
A2
A3
Baa1
Baa2
Baa3
Ba1
Ba2
Ba3
B1
B2
B3
Caa1
Caa2
Caa3
Ca
C
Aggregated Weighted
Total Factor Score"
< 1.50
1.50 - 2.49
2.50 - 3.49
3.50 - 4.49
4.50 - 5.49
5.50 - 6.49
6.50 -7.49
7.50 - 8.49
8.50 - 9.49
9.50 - 10.49
10.50 - 11.49
11.50 - 12.49
12.50 - 13.49
13.50 - 14.49
14.50 - 15.49
15.50 - 16.49
16.50 - 17.49
17.50 - 18.49
18.50 - 19.49
19.50 - 20.49
20.50 - 21.00
Indicated Sub-Factor
Rating
Factor or Sub-Factor
Score
Aaa - Aa
1.00 - 4.49
A
4.50 - 7.49
Baa
7.50 - 10.49
Ba
10.50- 13.49
B
13.50- 16.49
Caa - C
16.50- 21.49
The entire array of scores and mappings for each of the companies is shown in Appendix 1.
Moody's recognizes there are instances in which consolidated financial information may not capture a complete
picture of credit risk. This can occur for many reasons, the most common of which relates to recently completed or
pending mergers that are not yet reflected in reported historical data, reorganization activity, and the prospective
nature of a given rating. These instances are identified and explained as part of the overall rating mapping process and
assessment.
5. OUTLIER DISCUSSION
We recognize that not every factor will map to the actual rating level and that the rating therefore represents an overall
blend of the key factors. Any given company may perform higher or lower on a specific factor than its actual rating
level. We highlight those companies whose factor mapping is two or more rating categories higher or lower than its
rating and offer a discussion of the general reasons for outliers within a given factor. This document provides discussion of the general reasons for such outliers for each rating sub-factor.
The Five Key Rating Factors
RATING FACTOR 1: BUSINESS PROFILE
Why it matters
Business Profile is an important indicator of credit quality. The construction markets are characterized by high, but
local or regional, cyclicality. A positive business profile, demonstrated by geographical and/or product diversification
and strong market position in certain markets, helps to offset local or regional market weaknesses with strong markets
somewhere else. Diversification therefore is expected to lead to stability in cash flow and margins despite the generally
cyclical patterns in the construction industry. There are three sub-factors which aggregate into a single score, which is
then mapped to a specific rating.
Diversification
The first two sub-factors focus on geographical and product diversity, as diversity is deemed to provide a platform
from which a company can stabilize sales and protect earnings by offsetting variations in demand in a given product or
market. As most of the end customers of building materials producers are companies in the overall construction and
infrastructure industry, diversification in terms of end customer industry cannot typically be found.
Moody’s Rating Methodology
9
Issuers that score highly in this sub-category are invariably those issuers with sizeable revenues such as CRH and
Lafarge.
• Geographical diversification is viewed a positive factor because it reduces: (i) the company’s vulnerability to the
vagaries of a single region, (ii) the impact of economic cyclicality in individual regions, and (iii) the impact of
regional regulatory, environmental, product liability or safety (e.g. asbestos) issues.
• Product line diversification balances and offsets exposure to the volatility of demand and price competition in
particular industries and mitigates weaknesses in any one market or product line. However, the effectiveness of
this strategy has to be carefully analyzed with regard to the correlation of the individual segments. In many
instances, orders for various types of equipment used in different industries tend to coincide, reflecting the general
investment climate in a country rather than segment-specific trends.
The prime benefits of a large and diversified business mix should be captured by low revenue volatility and solid
profit margins. Effectively diversified companies should exhibit a greater degree of revenue consistency and scale
should bring operating efficiencies, normally reflected in higher profit margins. Revenue volatility is addressed in
Rating Factor 2; operating efficiency and profitability are discussed in Rating Factor 3.
Market Position
A strong competitive position in a regional market implies more robust pricing power and ability to produce sustainable future revenues and cash flows. For instance, those regional markets that are characterized by low competitive
threats are viewed as positive, whilst those markets with high competition are deemed as weak given a player’s limited
pricing power.
How We Measure it
The overall category score is made up of three criteria. For each of the three criteria we assign a discrete numerical
value (a 2, 4, 6 or 8) based on the following qualitative assessment:
Numerical
Value Assigned
% of
Overall Score
Product Line Diversity
25%
Geographic Diversity
Market Position
50%
25%
2
4
6
8
Majority of Cash
Flow is generated
from one business
line
< 3 country points*
Regional or niche
player
More than one
product line, but
heavily reliant on
one core segment
3 - 7 country points
Among the top five
players in only two
of its core markets**
More than three
product lines, which
vary in size and
profitability
8 - 12 country points
Among the top five
players in at least
three of its core
markets
More than three well
balanced profitable
product lines
> 12 country points
Among the top three
players in at least
three of its core
markets
* for calculation of country points, please refer to the following table
** Core market = core geographic markets in terms of revenue recognition
Product Line Diversity (25% of overall score): We assign the numerical value taking into consideration a company’s
number of product lines, their size and profitability. A company which has more than three well balanced profitable
product lines, such as Lafarge, will be assigned an 8.
Geographic Diversity (50% of overall score): As with Product Line Diversity, we assign a score of 2, 4, 6 or 8 to a
company.
As a first step we analyze the number of countries in which the company operates. For each country we assign
“country points”. As shown below, each country can account for 1 to 4 country points depending on the annual cement
consumption, which we take as a proxy for the size of the market for building materials.
10
Moody’s Rating Methodology
Cement Consumption p.a.
Max. Points Assigned Per Country*
Examples
> 100 bn tons
< 100 - 40 bn tons
< 40 - 10 bn tons
< 10 bn tons
4
3
2
1
China, India, USA
Japan, Spain, Russia
Brazil, Germany, Indonesia
Ukraine, Australia, Canada
* Max. number of points assigned for each country depends on company’s coverage of this country i.e. for a company that is
active in the USA, 4 points would only be assigned if the company covers the Northern, Southern, Eastern and Western parts of the
country
Translation Country of Points to Geographical Diversification Score
# of country points
score
> 12
8 - 12
3-7
<3
8
6
4
2
As a second step, the number of country points will then be translated into a score of a maximum 8 points. For
example, a total of 12 or more country points, which have been assigned to Cemex based on its broad geographic
diversification, translates into a score of 8.
Market Position (25% of overall score): The analysis of a company’s overall competitive position is based on an
assessment of its position in its core geographic markets in terms of revenue generation. If a company is only a regional
or niche player, a score of 2 would be assigned, as is the case for U.S. Concrete. Rinker Group will be assigned an 8 as
it is amongst the top three players in at least three of its core markets.
A company with a score of 8 in the sub-factor Product Diversity, 4 in Geographical Diversification and 8 in
Market Position would result in a total score of 6 (8*25% + 4*50%+8*25%), which would then result in a rating factor
rating of A.
Factor Mapping: Business Profile
Business Profile
Aaa-Aa
A
Baa
Ba
B
Caa-C
> 6.99
6.99 - 6.00
5.99 - 4.50
4.49 - 3.50
3.49 - 2.50
< 2.50
Applying the sub-factor weightings and scores for each of the three sub-factors results in the following business
profile assessment of the 12 companies:
Company Mapping: Business Profile
Moody’s
Rating
Rinker Group
Martin Marietta Materials
Boral
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCememt
Camargo Correa Cimentos
St. Marys Cement
U.S. Concrete
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
= Positive Outlier
Indicative
Factor
Rating
A
Ba
A
Aaa-Aa
Aaa-Aa
Aaa-Aa
Aaa-Aa
Ba
Aaa-Aa
Ba
B
B
Sub Total
6
3.5
6
8
8
7.5
8
4
7.5
3.5
3
3
Product
Line
Diversity
8
2
8
8
8
6
8
6
6
4
2
2
Geographic
Diversity
4
4
4
8
8
8
8
4
8
2
4
4
Market
Position
8
4
8
8
8
8
8
2
8
6
2
2
= Negative Outlier
Moody’s Rating Methodology
11
Observations and Outliers
Regional players in the industry are more exposed to regional cycles in the market and therefore have been assigned a
lower score. In general the European and Australian producers of building materials, such as CRH, Boral, Lafarge and
HeidelbergCement, as well as the Mexican cement producer Cemex, are among the leading and most diversified
companies in the world and therefore have been assigned a score which is better than their actual rating. This is
because the expansion of these companies has mainly been through debt-financed acquisitions. Martin Marietta Materials scores below its current rating category, which Moody’s notes is attributable to its exclusively North American
presence and narrow product breadth, which is primarily limited to construction aggregates.
RATING FACTOR 2: SIZE AND STABILITY
Why it matters
Size: The size of a company’s core business segments is considered to be a determinant of relative market strength and
operating flexibility. Absolute and relative size should provide a platform for sustainable earnings and cash flow. The
size of a business in the building material industry should also have a positive bearing on other key rating factors, such
as geographic and product diversification, flexibility of capacity allocation and cost absorption.
Size should positively influence an issuer’s ability to compete in absolute terms of its cost structure, including its ability
to invest in future projects.
Stability: In a business where regional cyclical swings in demand can influence revenues it is considered that those
building material producers showing only low geographic diversity will show a higher revenue volatility than those
more diversified producers which should be able to better balance different regional cycles. Moreover, companies
having a higher exposure to strongly growing emerging markets are likely to show comparatively higher revenue
growth patterns but they are also more exposed to higher volatility. Exceptionally strong revenue growth may also be a
sign of aggressive acquisition activity, which would also bear integration risk and would therefore score negatively on
this ratio.
High revenue volatility may not only reflect a company’s coverage imbalance; it can also influence profitability
should the company’s cost base not incorporate the necessary flexibility to adapt to capacity changes. Moody’s also
measures a company’s capacity to invest in its assets to derive value from existing and acquired business. Both these
effects are captured in rating factor 3.
How We Measure it
Size: We use the most recent annual revenues.
Stability: This factor is measured by calculating a five-year volatility of revenues using the standard deviation.
Factor Mapping: Size and Stability
Aaa-Aa
Scale / Size
Revenue Volatility
12
Moody’s Rating Methodology
A
> 12.50 $ bn 12.50 9.01 $ bn
< 3.00 %
3.00 % 7.49 %
Baa
Ba
B
Caa-C
9.00 3.01 $ bn
7.50 % 12.49 %
3.00 1.26 $ bn
12.50 % 17.49 %
1.25 0.26 $ bn
17.50 % 22.49 %
<0.26 $ bn
> 22.49 %
Company Mapping: Size and Stability
Company
Rinker Group
Martin Marietta Materials
Boral
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCememt
Camargo Correa Cimentos
St. Marys Cement
U.S. Concrete
Moody’s
Rating
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
Indicative
Factor
Rating
Scale / Size
in USD bn
B
Ba
Baa
A
Aa
Ba
Ba
Baa
Baa
B
B
Ba
= Positive Outlier
5.1
2.0
3.3
18.0
19.9
2.4
14.9
8.2
9.7
0.2
0.6
0.6
Indicative
Sub-Factor
Rating
Baa
Ba
Baa
Aaa-Aa
Aaa-Aa
Ba
Aaa-Aa
Baa
A
Caa-C
B
B
Revenue
Volatility
Indicative
Sub-Factor
Rating
26.1%
8.9%
11.3%
15.4%
6.5%
10.2%
43.4%
6.2%
8.1%
13.2%
20.1%
7.6%
Caa-C
Baa
Baa
Ba
A
Baa
Caa-C
A
Baa
Ba
B
Baa
= Negative Outlier
Observations and Outliers
The rating factor “Size and Stability” shows that the largest and most diversified companies in the industry, such as
Cemex and CRH, score high on the size sub-factor, but, because of external growth strategies, score less well on the
revenue stability sub-factor, indicating integration and other risks which are involved in a strategy of external growth.
Rinker, for example, has significantly grown revenues and corresponding margins since 2003, mainly due to external growth but also through internal growth projects. Therefore the standard deviation is negatively impacted. In this
case, Moody’s believes that this growth has been well managed and does not negatively impact on the company’s overall ratings.
Cemex’s Caa-C model rating for revenue stability is a result of the distorting effects of the RMC acquisition in
2005 on the standard deviation metric and the metric’s inability to reflect the significant integration progress made so
far. Our actual assessment affords management some time to implement its strategy.
RATING FACTOR 3: COST POSITION AND PROFITABILITY
Why it matters
Given the industry’s cyclical character, a company’s ability to manage its overall cost structure and operating efficiency
is a critical factor in the rating analysis.
Factors that measure costs and operating efficiency help in assessing a company's ability to operate through
economic downturns and its ability to service its debt. Debt coverage is also influenced by other obligations, which can
vary extensively on a geographic basis due to regulatory, environmental compliance and other differences.
There are three sub-factors that Moody’s focuses on when analyzing the cost efficiency and profitability of building materials producers:
• Operating Margin
• Operating Margin Stability
• Return on Average Assets
How We Measure it
Operating Margin: A five-year average of annual Operating Profit divided by annual revenue. This is a critical
measurement for analyzing the underlying operational profitability of a building materials producer. While Moody’s
looks to maintain some stability in ratings in different operating and economic environments and considers the prior
two to three years’ results in combination with expectations for the next two years, this methodology uses, for illustrative purposes, the average Operating Profit to revenue ratio of the past five years as a proxy for performance through
both peak and trough scenarios.
Operating Margin Stability: The volatility of a five-year Operating Margin based on the standard deviation.
Moody’s Rating Methodology
13
Return on Average Assets: This is a strong measure of a company’s ability to generate a consistent and meaningful
return from its asset base. This metric specifically takes into account the capital-intensive nature of the industry. This
is also a five-year average measurement. In each year, where available, EBIT is divided by the average of the current
and last year’s assets and the resulting group of ratios is averaged into a single metric. ROAA therefore gives us valuable
insight into management's execution ability, by measuring its capacity to continue investing in the right assets to derive
value from the business.
Factor Mapping: Cost Position and Profitability
Aaa-Aa
A
Baa
Ba
B
Caa-C
Profitability
> 20.00 %
< 5.00 %
Return on Average Assets
> 15.00%
15.00 % 10.01 %
10.00 % 17.49 %
12.50 % 7.51 %
10.00 % 7.51 %
17.50% 24.99 %
7.50 % 4.01 %
7.50 % 2.51 %
25.00 % 39.99 %
4.00 % 2.01 %
< 2.51 %
Profitability Volatility
20.00 % 15.01 %
5.00 % 9.99 %
15.00 % 12.51 %
> 39.99%
< 2.01%
Factor Mapping: Cost Position and Profitability
Company
Moody’s
Rating
Rinker Group
Martin Marietta Materials
Boral
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCememt
Camargo Correa Cimentos
St. Marys Cement
U.S. Concrete
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
Indicative
Factor
Rating
A
Baa
Ba
Baa
Baa
Ba
A
Ba
Ba
Baa
Baa
B
= Positive Outlier
5 y average
Operating
Margin
15.5%
13.7%
9.5%
9.3%
13.4%
11.4%
21.1%
4.7%
9.8%
20.4%
17.4%
5.6%
Indicative
5y
Indicative
Sub-Factor Operating Sub-Factor
Rating
Margin Vol.
Rating
A
Baa
Ba
Ba
Baa
Baa
Aaa-Aa
B
Ba
Aaa-Aa
A
B
23.4%
14.7%
33.6%
6.0%
5.9%
39.7%
13.0%
14.9%
29.0%
58.2%
12.1%
34.2%
Ba
Baa
B
A
A
B
Baa
Baa
B
Caa-C
Baa
B
5 y ROAA
19.5%
10.0%
10.2%
9.7%
7.8%
8.0%
7.7%
4.3%
6.4%
13.5%
8.1%
5.3%
Indicative
Sub-Factor
Rating
Aaa-Aa
Baa
Baa
Baa
Baa
Baa
Baa
Ba
Ba
A
Baa
Ba
= Negative Outlier
Observations and Outliers
Taiheiyo is a negative outlier in the operating margin. Although Taiheiyo’s margin level is lower than those of global
peers, the low volatility of its business and margin has allowed it to generate relatively stable cash flow.
Cemex’s Aaa-Aa score on profitability is heavily influenced by the company’s dominant position in its Mexican
home market, where important barriers to entry for imports exist and cement can be sold as a branded consumer
product that generates premium margins. However, over the coming years profitability will likely fall into a single A
category because of the lower profitability of the acquired RCM business, which is not yet fully reflected in the historical five year operating margin average shown above.
Although demand for cement in Brazil has stagnated in recent years at a relatively low level and the industry has
reported an average idle capacity of 50%, until 2004 prices were successfully managed so as to provide strong operating
margins of 25.6% on average in the period 2001-2004. In 2005, the entrance of new players producing cement from
imported clinker led established producers to reduce prices to defend their market shares, resulting in a dramatic
decline in Camargo Correa’s operating margin to negative 0.6%. The 5-year average operating ratios primarily reflect
the strong margins recorded in the 2001-2004 period. Moody’s expects some price recovery over the medium term,
although only as far as 10% - 15%, equivalent to the Baa category, given the ongoing constraints of the high idle capacity of the industry.
The volatility of the operating margin gives an indication of the business risk the companies are facing due to the
cyclicality of their local markets. Accordingly, the larger and more diversified companies such as CRH or Lafarge score
high on this factor as they are able to continuously report stable margins. In contrast, Wienerberger, which has been
exposed to the weak German, Polish and Hungarian construction industries, scores relatively low, despite its good
geographic diversification.
14
Moody’s Rating Methodology
Given Boral’s impressive improvement in margins over the last five years the company scores low for volatility in
operating profitability. Apart from improving operating efficiency, these strong margins have also been achieved
during a period of strong demand levels within the Australian economy for new dwellings and as a result building
materials, and reflect Boral's dependency on the Australian market.
St. Marys Cement’s operations are almost entirely restricted to cement, which has historically been a more stable
and higher-margin business than downstream aggregates and concrete. St. Marys Cement’s return on assets is also artificially inflated having excluded the leasing arrangement with its parent for two cement plants, purchased from Cemex
in 2005, in historical figures.
Concrete production tends not to be as capital-intensive as cement and aggregates production, which supports the
return on assets score for US Concrete, the largest independent ready-mixed concrete producer in the US.
RATING FACTOR 4: FINANCIAL MANAGEMENT STRATEGY
Why it matters
A company's financial policies are a critical component in the rating process for building materials companies as they
provide insight into management’s philosophy regarding the company's capital structure and the financial risk under
which it is willing to operate. For example, the more modest a company's debt levels, the greater the financial flexibility it has for coping in the industry's valleys.
Our analytical focus will be on targeted capital structure, debt levels, dividend policy including share repurchases,
funding requirements for capital expenditure parameters, M&A activity and the respective financing, liquidity management and tolerance within a band of financial metrics.
A debt rating is focused on the ability of an issuer to service its debt obligations in a timely manner and, therefore,
any cash outflow that would otherwise have been designated to repaying debt or strengthening the future credit profile
of the business is viewed as negative or at best as neutral.
In addition to quantitative factors, various qualitative considerations such as debt maturity profiles are also considered in the analysis of financial policies. Ratios used in this area are felt to be the most revealing credit metrics and
further provide an indication of a company's financial flexibility based on cash flow to debt measurements.
The conservativeness of the capital structure will also provide flexibility to absorb shocks or credit events, such as
M&A activity. M&A is a common feature of the industry, which exhibits modest organic growth, with companies
prone to enter into corporate activity to spur revenue growth, expand business lines, consolidate market positions,
advance cost synergies or seek to access raw materials or new technology. The impact of an acquisition on a rating will
invariably depend on the current capital structure and upon the size of the acquisition target, its cash flow characteristics and funding structure.
The methodology uses two leverage ratios: debt to capital and debt to EBITDA. These serve to demonstrate the
overall level of debt employed in the capital structure as well as the level by which debt exceeds the earnings generation
capability of the company.
Debt to Capitalization: Although not a dynamic measure, debt to capital is a simple way to compare the capital structures of companies operating within an industry. It also provides some insight into a company’s financial policies and
shareholder strategies, including its tolerance for debt levels. Further, it is an important indicator for the cyclical building materials industry in that it provides a snapshot of overall debt in the capital structure and, therefore, a window
into a company’s ability to ride out a downturn in performance.
Debt to EBITDA is a measure that balances the debt to capitalization ratio with the measurement of a company’s
ability to cover debt with a proxy level of cash flow, as indicated by EBITDA.
How We Measure it
Debt to Capitalization: The debt to capital ratio is based on the most recent fiscal year. The discussion of this ratio
will also incorporate analysis of an issuer's funding sources and debt maturity profile, target capitalization levels and
performance against such targets as well as a company's acquisition history and philosophy on share repurchases and
special dividends.
Debt to EBITDA: is measured by a five-year average, which is illustrative of performance through a high and low
pricing environment.
Moody’s Rating Methodology
15
Factor Mapping: Management Strategy
Aaa-Aa
A
Baa
Ba
B
Caa-C
Debt / Capitalisation
< 20.00 %
< 1.50 x
30.00 % 44.99 %
2.50 x 3.49 x
45.00 % 64.99 %
3.50 x 4.49 x
65.00 % 79.99 %
4.50 x 5.99 x
> 79.99%
Debt / EBITDA
20.00 % 29.99 %
1.50 x 2.49 x
> 5.99 x
Company Mapping: Management Strategy
Moody’s
Rating
Company
Rinker Group
Martin Marietta Materials
Boral
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCememt
Camargo Correa Cimentos
St. Marys Cement
U.S. Concrete
Indicative
Factor
Rating
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
= Positive Outlier
Aa
Ba
Baa
Ba
Ba
Ba
Ba
Caa
Ba
Baa
Baa
Caa
Indicative
Sub-Factor
Debt /
Capitalisation
Rating
24.9%
45.9%
40.5%
47.1%
46.0%
46.8%
46.8%
71.4%
45.3%
30.4%
39.4%
73.8%
A
Ba
Baa
Ba
Ba
Ba
Ba
B
Ba
Baa
Baa
B
Debt /
EBITDA
1.1
2.7
2.0
2.8
3.9
3.0
3.3
8.5
4.0
3.1
2.9
8.5
Indicative
Sub-Factor
Rating
Aaa-Aa
Baa
A
Baa
Ba
Baa
Baa
Caa-C
Ba
Baa
Baa
Caa-C
= Negative Outlier
Observations and Outliers
Taiheiyo is a negative outlier based on the financials as of March 2005. However, according to the flash report as of
March 2006, the Debt to Capitalization ratio will strongly improve and the gap for the rating will therefore become
smaller. On the debt to EBITDA figure Taiheiyo is also a negative outlier but this measure has been continuously
improving over the past year. Moody’s expects that this trend will continue following the expected debt reduction in
the coming years. The Baa3 rating already incorporates the improvement in the medium term.
While Camargo Correa’s Debt to Capitalization ratio of 30.4% translates into a Baa rating, Moody’s understands
that companies operating in emerging markets, where funding costs are higher and the financial market is more
volatile, should report a stronger capital structure than those peers operating in developed countries. Accordingly,
Moody's sees Camargo Correa’s 30.4% ratio as more reflective of a Ba rating. For the same reason, Moody’s believes
the 3.1x 5-year average ratio for the Debt to EBITDA sub-factor is more reflective of a Ba rating.
RATING FACTOR 5: FINANCIAL STRENGTH
Why it matters
Companies in the cyclical building material industry need to generate sufficient earnings and cash flow to cover their
capital expenditures, in addition to dividends, interest expense and debt amortization. The three key indicators we use
to measure financial strength are: (i) interest coverage, (ii) retained cash flow relative to net debt, and (iii) free cash flow
relative to debt.
Interest coverage: Interest coverage can be particularly meaningful for speculative grade companies. This is especially true if the interest rate environment is in a period of change – such as the migration from lower rates to higher
rates – and an issuer is facing the need to refinance debt that is nearing maturity. For higher-rated companies, this
metric is viewed more as a proxy for financial flexibility.
The remaining two metrics relate to the amount of cash flow available to cover varied scenarios of both operating
needs and financing needs.
• Operating needs include major items such as working capital and capital spending.
• Financing needs refers to the impact of dividends and the "free" cash then available to service debt.
16
Moody’s Rating Methodology
Retained Cash Flow is a broader measure of financial flexibility than free cash flow as it excludes the potential 'noise'
created by changes in working capital and unusual capital spending programs.
Free Cash Flow is, in many instances, one of the most important and reliable measures of financial strength and flexibility. This metric reflects a company's primary source of liquidity as it directly speaks to management’s ability to
service its debt burden after considering both its operating and financial commitments to shareholders. In this metric
we often identify the relative risks associated with capital spending programs. At times, programs can have a direct
impact on ratings because of the size of expenditure that may be involved as well as the risks of executing the program
on time and on budget. If, for example, a large amount of capital is spent on new greenfield capacity and we believe
that such capacity is being added at a time when product prices are low (i.e. there is a lack of an adequate return on this
capital), the ratings may be negatively affected. There is also the risk that anticipated operating cash cost benefits upon
project completion are different than expected.
How We Measure it
Interest Coverage: The five-year average of EBIT to gross interest expense
Retained Cash Flow to Net Debt: Funds from operations less dividends divided by net debt, calculated as average of
past five years.
Free Cash Flow to Debt: The five-year average of cash from operations minus capital expenditures and dividends
divided by gross debt
Factor Mapping: Financial Strength
Aaa-Aa
A
Baa
Ba
B
Caa-C
EBIT / Interest
> 10.00 x
> 60.00 %
FCF / Debt
> 22.5 %
7.00 x 4.01 x
40.00 % 20.01 %
17.50 % 7.01 %
4.00 x 2.01 x
20.00 % 10.01 %
7.00 % 4.01 %
2.00 x 1.01 x
10.00 % 5.01 %
4.01 % 1.00 %
< 1.01 x
RCF / Net Debt
10.00 x 7.01 x
60.00 % 40.01 %
22.50 % 17.51 %
< 5.01 %
< 1.00 %
Company Mapping: Financial Strength
Company
Rinker Group
Martin Marietta Materials
Boral
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCememt
Camargo Correa Cimentos
St. Marys Cement
U.S. Concrete
Moody’s
Rating
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
Indicative
Factor
Rating
Aa
Baa
Ba
Baa
Ba
Ba
Baa
B
Ba
Baa
Ba
Ba
= Positive Outlier
EBIT
Interest
13.1
3.7
4.7
5.2
3.5
3.3
3.1
3.4
2.3
1.8
3.3
1.1
Indicative
Sub-Factor
Rating
Aaa-Aa
Ba
Baa
Baa
Ba
Ba
Ba
Ba
Ba
B
Ba
B
RCF / Net
Debt
92.4%
28.4%
28.2%
37.5%
17.7%
20.3%
23.0%
7.3%
18.2%
54.4%
21.6%
14.7%
Indicative
Sub-Factor
Rating
Aaa-Aa
Baa
Baa
Baa
Ba
Baa
Baa
B
Ba
A
Baa
Ba
FCF /
Gross Debt
30.3%
7.5%
1.7%
14.3%
4.1%
3.0%
15.9%
1.3%
4.4%
14.5%
2.8%
6.1%
Indicative
Sub-Factor
Rating
Aaa-Aa
Baa
B
Baa
Ba
B
Baa
B
Ba
Baa
B
Ba
= Negative Outlier
Moody’s Rating Methodology
17
Observations and Outliers
Taiheiyo is a negative outlier for RCF/ Net adj. Debt and FCF/ Gross Debt. Moody’s expects Taiheiyo’s ratios to
improve in the financial year to March 2006 and in the following years. These improvements have already been incorporated into the current Baa3 rating.
As Boral has strong market shares in key Australian states, domestic competition regulations impede its ability to
grow via acquisitions, as was seen when it attempted to acquire Adelaide Brighton. As a result, organic growth,
through expanding current production facilities and new greenfield operations, provides the primary avenue for Boral’s
future growth. As there is usually a delay between the expenditure of these amounts and the deriving of corresponding
earnings and cash flows in subsequent periods, Boral scores low on the FCF/debt ratio. The same applies to Wienerberger. The expansion into emerging markets is primarily done via new greenfield investments, rather than via acquisitions of outdated plants in the respective markets. The FCF/debt metric is also negatively impacted by the time gap
between the investment and the cash flows achieved from the investment.
Martin Marietta Materials' interest coverage score is limited by lower margins attained during the 2002-2003
economic slowdown in the US, although EBIT margins have rebounded significantly since that period. Similarly,
Martin Marietta Materials' free cash flow generation is currently constrained by its aggressive capital spending efforts
in the US and Nova Scotia, resulting in a Ba FCF/Debt score that is inconsistent with its current rating category.
Other Rating Considerations
Other Risk Factors
The rating assessment also typically considers other risks that cannot be readily captured in the grid because they are
specific to certain companies. Other factors reflected in Moody’s ratings include:
• Quality of management
• Corporate governance
• Liquidity management
• The extent, quality, comparability and frequency of financial disclosure
• Event Risk of major debt-financed acquisitions
These rating considerations are common to all corporate finance issuers and are therefore not specifically or
extensively captured in our building materials rating methodology. However, the analysis of these factors remains an
integral part of our rating process and is described in a number of separate reports published by Moody’s.
Net Debt Versus Gross Debt
A number of the ratios used in this methodology are presented on a gross debt basis, whereas the RCF to net debt is
presented on a net debt basis (i.e. gross debt minus cash and cash equivalents). In fact, Moody’s takes both into
consideration:
• Cash balances are partly working cash which needs to remain in the business. In the US in particular, cash balances are generally modest and are generally only from working capital.
• Moreover, cash may be in subsidiaries or jurisdictions in which friction costs (e.g. income taxes, withholding taxes)
may make it inappropriate to use net debt. Plus, there could be covenant restrictions limiting the ability of cash to
go upstream into holding companies.
• In Europe and emerging markets in general, a number of companies prefer to centralize cash balances on the
books of the holding company, while maintaining debt at the subsidiary level. We also generally observe a higher
willingness of European and emerging market companies to maintain higher cash balances, which may sometimes
be linked to tax considerations, or more broadly the consequence of a higher level of caution on the availability or
volatility of funding in the bank or bond markets and considering that committed credit facilities are not usual in
emerging markets. Considering only gross debt may not reflect the real financial strength of these companies and
Moody’s may consider focusing on net debt. However, in this case we assess the quality of liquidity, including the
expectation that cash balances can be liquidated at least at book value and without tax costs.
Standard Adjustments
Consistent with Moody’s standard adjustments, we adjust financial statements for operating leases (using a 5x
multiple), unfunded pension liabilities, hybrid securities and other standard adjustments. Consistent with our approach
to adjust full sets of financial statements, we adjust the components of capitalization for these same items.
18
Moody’s Rating Methodology
Do We Look at Financial Metrics Differently in Speculative Grade?
We use the same credit metrics across the entire rating scale. However, for speculative-grade companies we place
additional emphasis on the following:
• Access to liquidity is a key rating differentiator. In our analysis, we focus on external committed facilities, covenant
cushion as well as the access to capital markets. In emerging markets, where committed credit facilities are not
usual, the consistent maintenance of adequate level of cash position is observed by Moody’s.
• Ability to de-leverage the business. As a result, we would look at existing credit metrics, and take a stance on where the
metrics are likely to be over the medium term, and how likely the issuer is to achieve these metrics. If we are very
comfortable that the fundamental operations of an issuer will allow a material improvement in metrics over the
next 12 to 18 months, this will be factored into our assessment of the rating grid.
• A prospective view on metrics can also be more critical in speculative grade, because historical financial statements may be
unrepresentative of current and expected financial performance due to growth, a series of acquisitions, or deterioration in the current operating environment. In such cases, we focus on pro-forma financials as a starting point for
our assessment. Financial projections are critical in our analysis because they are based on the more recent and
likely future performance. Projections incorporate considerable assumptions. By starting with a pro forma, we can
identify positive gaps in assumptions.
• Cash-flow variations are much more critical for speculative-grade issuers than for their investment-grade counterparts.
As a result, we may choose to focus more on cyclical and seasonal cash flow variations and on the absolute level of
free cash flows than would be the case for investment-grade issuers.
• As a company’s rating approaches investment grade, we assign a higher weighting to qualitative factors, particularly its
overall risk appetite and the quality of its business model as an indicator for revenue sustainability. Companies that
lack scale or diversification, have a weak market position or operate in unattractive categories may never reach
investment grade. If a company’s operating performance is moderately weak in one of these respects or if a management team has historically displayed a high tolerance for risk through acquisition activity or financial policy, we
may require stronger credit metrics for an upgrade into investment grade than might otherwise be the case. As a
result, some Ba-rated companies have stronger credit metrics than Baa-rated companies with a more robust business model and a lower risk appetite.
Final Consideration
Appendix 1 illustrates the mapping and ratios for each of the measured factors as well as each company’s overall
implied rating using weightings as indicated in the Appendix. For each factor we have highlighted favorable and unfavorable outliers of two or more full rating categories..
For the 12 selected building materials companies analyzed in this methodology, we make the following observations:
• The indicated ratings of 8 of the 12 companies (66 2/3%) either match the current rating or fall within one notch of it.
• Three companies (25%; 91 2/3% cumulative) have indicated ratings that are two notches higher or lower than
their current ratings.
• Only one company has an indicated rating that is three notches higher or lower than the existing rating.
Further conclusions are:
• We believe that the rating methodology is useful in identifying companies that fall outside of the indicated ranges
for individual measurement criteria – either favorably or unfavorably – and determining whether there are offsetting factors to compensate for this.
• As can be seen in the chart in Appendix 1, the indicated rating categories for some of the companies vary considerably across the factors. Especially smaller companies, such as St. Marys Concrete or U.S. Concrete score high in
terms of margin, and cash flow to debt measures, but lack the geographic and business diversity which is expected
to heavily expose these companies to the local cycle in the construction industry.
• Although all main rating factors are weighted equally in arriving at the mapped rating, the measurement of the
degree of leverage employed in the capital structure relative to both earnings and cash flow generation is a particularly important rating consideration, as are size and business profile. Overall, debt is represented in four of the
nine financial metrics, and the business profile and size is represented in four of all 13 rating sub-factors.
• According to the methodology, Moody’s allows companies with a broader business profile and diversification to
have a higher leverage and indebtedness than companies with a more limited and focused business model to
achieve the same rating category. Therefore, despite scoring relatively low in terms of Financial Strength and
Management Strategy, Lafarge, for example, maps comfortably to the Baa category.
Moody’s Rating Methodology
19
Related Research
Rating Methodologies:
Moody’s Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial
Corporations – Part I, February 2006 (96760)
Moody’s Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial
Corporations – Part II, February 2006 (96729)
Industry Outlook:
European Building Materials, February 2006 (96813)
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this
report and that more recent reports may be available. All research may not be available to all clients.
20
Moody’s Rating Methodology
Moody’s Rating Methodology
21
A3
A3
Baa1
Baa1
Baa2
Baa2
Baa3
Baa3
Ba1
Ba3
Ba3
B1
Moody’s
Rating
A3
Baa3
Baa2
A3
Baa1
Baa2
Baa1
Ba2
Baa2
Ba1
Ba2
B1
Mapped
Rating
Category
A
Ba
A
Aaa-Aa
Aaa-Aa
Aaa-Aa
Aaa-Aa
Ba
Aaa-Aa
Ba
B
B
2
1
Business
Profile*
3
10%
Baa
Ba
Baa
Aaa-Aa
Aaa-Aa
Ba
Aaa-Aa
Baa
A
Caa-C
B
B
Revenues
Caa-C
Baa
Baa
Ba
A
Baa
Caa-C
A
Baa
Ba
B
Baa
Revenue
Volatility
Size & Stability
10%
20%
5
6.67%
6
6.67%
A
Baa
Ba
Ba
Baa
Baa
Aaa-Aa
B
Ba
Aaa-Aa
A
B
Ba
Baa
B
A
A
B
Baa
Baa
B
Caa-C
Baa
B
Aaa-Aa
Baa
Baa
Baa
Baa
Baa
Baa
Ba
Ba
A
Baa
Ba
Cost Position & Profitability
Operating
Operating
Margin
Margin
Volatility
ROAA
4
6.67%
8
10%
A
Ba
Baa
Ba
Ba
Ba
Ba
B
Ba
Baa
Baa
B
Debt /
Cap.
Aaa-Aa
Baa
A
Baa
Ba
Baa
Baa
Caa-C
Ba
Baa
Baa
Caa-C
Debt /
EBITDA
Management Strategy
7
10%
10
6.67%
Aaa-Aa
Ba
Baa
Baa
Ba
Ba
Ba
Ba
Ba
B
Ba
B
Aaa-Aa
Baa
Baa
Baa
Ba
Baa
Baa
B
Ba
A
Baa
Ba
RCF /
Net Debt
11
6.67%
Aaa-Aa
Baa
B
Baa
Ba
B
Baa
B
Ba
Baa
B
Ba
FCF /
GrossDebt
Financial Strength
EBIT /
Interest
9
6.67%
* This Rating Factor includes three sub factors: Product Line Diversity (applied weight of 5%), Geographic Diversity (applied weight of 10%) and Market Position (Applied weight of 5%)
Rinker Group
Martin Marietta
Boral Limited
CRH
Lafarge
Wienerberger
Cemex
Taiheiyo
HeidelbergCement
Camargo Correa
St. Marys Concrete
U.S. Concrete
Applied Weights
Appendix 1: Model Rating Summary
Appendix 2
Ratings Grid
Rating Category
Aaa-Aa
A
Baa
Ba
B
Caa-C
1) Business Profile
Business Profile Assessment
> 6.99
6.99 - 6.00
5.99 - 4.50
4.49 - 3.50
3.49 - 2.50
< 2.50
2) Size & Stability
Revenues (USD bn)
> 12.50 $ bn
12.50 9.01 $ bn
3.00 % 7.49 %
9.00 3.01 $ bn
7.50 % 12.49 %
3.00 1.26 $ bn
12.50 % 17.49 %
1.25 0.26 $ bn
17.50 % 22.49 %
< 0.26 $ bn
20.00 % 15.01 %
5.00 % 9.99 %
15.00 % 12.51 %
15.00 % 10.01 %
10.00 % 17.49 %
12.50 % 7.51 %
10.00 % 7.51 %
17.50% 24.99 %
7.50 % 4.01 %
7.50 % 2.51 %
25.00 % 39.99 %
4.00 % 2.01 %
< 2.51 %
20.00 % 29.99 %
1.50 x 2.49 x
30.00 % 44.99 %
2.50 x 3.49 x
45.00 % 64.99 %
3.50 x 4.49 x
65.00 % 79.99 %
4.50 x 5.99 x
> 79.99%
10.00 x 7.01 x
60.00 % 40.01 %
22.50 % 17.51 %
7.00 x 4.01 x
40.00 % 20.01 %
17.50 % 7.01 %
4.00 x 2.01 x
20.00 % 10.01 %
7.00 % 4.01 %
2.00 x 1.01 x
10.00 % 5.01 %
4.01 % 1.00 %
< 1.01 x
Revenue Volatility
(5 yr. Standard Deviation)
3) Cost position and Profitability
Operating Margin (5 yr. average)
Operating Margin Volatility
(5 yr. Standard Deviation)
Return on Average Assets
(5 yr. Average)
< 3.00 %
> 20.00 %
< 5.00 %
> 15.00%
4) Management Strategy
Debt / Capitalisation
< 20.00 %
Debt / EBITDA (5 yr. Average)
< 1.50 x
5) Financial Strength
EBIT / Interest (5 yr. Average)
> 10.00 x
RCF / Net Debt (5 yr. average)
> 60.00 %
FCF / Debt (5 yr. average)
> 22.5 %
22
Moody’s Rating Methodology
> 22.49 %
> 39.99%
< 2.01%
> 5.99 x
< 5.01%
< 1.00%
Appendix 3: Key Ratio Definitions
OPERATING MARGIN (5 YEAR AVERAGE)
Adjusted Operating Profit = Operating Profit + 1/3 Lease Expense
Operating Margin (%) = 5 Year Average of Operating Profit Divided by Annual Revenues
RETURN ON AVERAGE ASSETS (5 YEAR AVERAGE)
EBIT = Pretax Income + Interest Expense
Total Average Assets = Average Assets of the Last Two Years Divided by Two
ROAA (%) = 5 year Average of EBIT Divided by Total Average Assets
DEBT TO BOOK CAPITALIZATION
Debt as Reported = ST Debt + LT Debt
Capitalization = Debt as Reported + Deferred Taxes + Minority Interest + Book Equity
Debt to Book Capitalization (%) = Most Recent Year’s Debt Divided by Most Recent Year’s Capitalization
GROSS DEBT TO EBITDA (5 YEAR AVERAGE)
Gross Debt = ST Debt + LT Debt + Operating Leases + Pension Liabilities + Securitization + Preferred Shares &
Hybrids + Guarantees
EBITDA = EBIT + Depreciation & Amortization
Debt to EBITDA = 5 Year Average of Annual Year End Debt Divided by Annual EBITDA
INTEREST COVERAGE (5 YEAR AVERAGE)
Interest Expense = Interest paid + Capitalized Portion of Interest
Interest Coverage = 5 Year Average of Annual EBIT Divided by Annual Interest Expense
RETAINED CASH FLOW TO NET DEBT (5 YEAR AVERAGE)
Retained Cash Flow = Funds From Operations (pre Working Capital) – Dividends
Net Debt = ST Debt + LT Debt + Operating Leases + Pension Liabilities + Securitization + Preferred Shares &
Hybrids + Guarantees – Cash and Cash Equivalents
Retained Cash Flow to Net Debt = 5 Year Average of Annual Retained Cash Flow Divided by Net Debt
FREE CASH FLOW TO GROSS DEBT
Free Cash Flow = Cash Flow from Operations – Dividends – Capex
Free Cash Flow to Gross Debt = 5 Year Average of Annual Free Cash Flow Divided by Gross Debt
Moody’s Rating Methodology
23
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contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY,
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This credit rating opinion has been prepared without taking into account any of your objectives, financial situation or needs. You should, before acting on the opinion, consider the
appropriateness of the opinion having regard to your own objectives, financial situation and needs.
24
Moody’s Rating Methodology