CORPORATES
CREDIT OPINION
15 July 2016
Heraeus Holding GmbH
Update to Key Credit Considerations
Update
Summary Rating Rationale
Heraeus’ Baa1 is supported by its broad product offering and leading market positions
within many of its business units. These market positions are to some degree protected by
barriers to entry given the company's extensive know-how in precious metal processing, long
standing relationships with industrial customers and mining companies as well as numerous
patents.
RATINGS
Heraeus Holding GmbH
Domicile
Germany
Long Term Rating
Baa1
Type
LT Issuer Rating - Fgn
Curr
Outlook
Stable
Please see the ratings section at the end of this report
for more information.The ratings and outlook shown
reflect information as of the publication date.
Analyst Contacts
Jeanine Arnold
49-69-70730-789
VP-Senior Analyst
jeanine.arnold@moodys.com
Moritz Melsbach
49-69-70730-784
Associate Analyst
moritz.melsbach@moodys.com
The company is, however, weakly positioned at the current rating level. This is because
operating and cash flow performance has gradually weakened over the last two to three
years and been consistently lower relative to both our and the company's expectations.
We believe the company's weaker operating performance and the lower degree of earnings
visibility stem from the fact that over time the company has developed a less focused
product portfolio, which has made the company less apt in addressing more challenging
economic conditions. In particular profitability measured as adjusted EBITA from nonprecious metal sales has declined to €204 million (EBITA margin: 10.6%) in 2015 from
around €393 million (EBITA margin: 20%) in 2012. This weaker operating performance has
driven a marked increase in Heraeus’ leverage to around 3.4x debt/EBITDA as at 2015 from
around 2.5x in 2012.
We expect improvements in profitability, free cash flow and leverage in 2016 with further
improvements expected in 2017. This is because we believe challenging operating conditions
for some of its product lines are easing, and management appears much more intent on
restructuring and refocusing its product portfolio than it has done in the past. We believe
Heraeus' cash flow generation, its substantial cash balance of around €1.0 billion and
commitment to a conservative financial profile provide the company with the financial
means and time for restructuring measures to take effect and establish a more sustainable
operating model. Heraeus’ adjusted net debt/EBITDA was around 0.3x as at December 2015.
Credit Strengths
»
Leading global market positions
»
Technological know-how creates barriers to entry
»
Strong balance sheet and liquidity sufficient to absorb earning pressures and undertake
restructuring
CORPORATES
MOODY'S INVESTORS SERVICE
Credit Challenges
»
Diversified end market exposure has not fully mitigated profit and FCF volatility
»
Limited earnings visibility as evidenced by underperformance relative to expectations
»
High gross leverage
Rating Outlook
Heraeus is weakly positioned at the Baa1 rating level given its weak earnings and cash flow generation as well as its persistent
underperformance relative to expectations. However, the stable outlook reflects our expectation that Heraeus' operating performance
will begin to improve as of 2016 and that the company will continue to maintain a disciplined conservative financial policy, including a
solid liquidity profile. We expect that improved earnings should also allow Heraeus to sustainably reduce leverage towards 2.5x in the
next 12 to 18 months.
Factors that Could Lead to an Upgrade
Owing to Heraeus' weak positioning at the Baa1 rating level, an upgrade is currently unlikely. An upgrade of Heraeus’ rating would
require a sustainable improvement in EBITA margins on a non-pm sales basis to the high teens as well as greater earnings visibility and
predictability. In addition, a rating upgrade would require a track record of consistently generating positive FCF in excess of 10% FCF/
Debt as well as maintaining debt/EBITDA below 2.0x and a strong liquidity profile.
Factors that Could Lead to a Downgrade
Negative rating action is likely if the company fails to expand its EBITA margin on non-pm sales towards the mid-teens in the next
12-18 months. In our view this would evidence more persistent structural weaknesses in the company’s business profile and markets,
and the need for further restructuring. Likewise debt/EBITDA remaining in excess of 2.5x beyond 2017 and a failure to improve (RCFCapex)/debt to around 10% (2.3% in 2015) on a sustainable basis could also lead to negative rating action, a material deterioration of
Heraeus’ liquidity profile could also result in negative pressure on the rating.
Key Indicators
Exhibit 1
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
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Heraeus Holding GmbH: Update to Key Credit Considerations
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MOODY'S INVESTORS SERVICE
Detailed Rating Considerations
LEADING GLOBAL MARKET POSITIONS WITH BARRIERS TO ENTRY DUE TO TECHNOLOGICAL KNOW-HOW
Heraeus ranks among the top three players in the majority of its globally-diversified markets, which are considered relatively
consolidated and profitable. In particular, Heraeus is active in melting and processing precious metals for recycling purposes, industrial
products based on precious metals such as catalysts for the chemical industry and solder pastes for integrated circuits. Heraeus is also
a leading player in the manufacture of sensors for the steel industry, bone cements for endoprosthetics, quartz glass and specialty light
products .
In addition, Heraeus is one of the biggest industrial precious metal traders worldwide, which includes the sourcing, handling and
management of precious metals and the control of market risks on behalf of its industry customers. These activities also safeguard the
supply of precious metals for Heraeus' own manufacturing activities. Heraeus' technological expertise in the precious metal processing,
numerous patents, its good relationships with industry customers as well as mining companies represent sound entry barriers.
DIVERSIFIED END MARKET EXPOSURE HAS NOT MITIGATED EARNINGS AND FCF VOLATILITY, BUT RESTRUCTURING MEASURES SHOULD BEGIN TO
ADDRESS THIS
Heraeus benefits from a diversified industry and product portfolio, as well as good geographical diversification. It operates in different
industries including energy, chemicals, healthcare, mobility, communication and steel. Heraeus' revenues are also well spread by
customer and economic regions. This diversified product portfolio allows the company to reduce top-line and earnings volatility to
some degree. For example, Heraeus’ Health segment has continued to generate relatively strong earnings and this has enabled the
company to offset declines in its Industrial Applications business.
At the same time, we believe the company’s broad product and geographic portfolio has also developed a less focused product
portfolio and critical mass, which we believe has exacerbated losses in some of the company's business units and contributed to
the company’s earnings and FCF volatility. Adjusted EBITA has fallen consecutively, and contrary to Moody's and the company’s
expectations over the last few years. In 2015 Moody's adjusted EBITA was €204 million, compared with €393 million in 2012 and
around €510 million in 2011 when photovoltaic fundamentals were exceptionally strong. In addition, between 2009 and 2015 adjusted
FCF has fluctuated between €-32 million in €126 million (2015 and 2012).
These fluctuations represent a high level of volatility when compared to other investment grade rated manufacturing peers. In contrast
to many other peers rated under the global manufacturing methodology Heraeus’ does not have a sizeable order backlog or a sizeable
service business providing the company with strong revenue visibility. This, in combination with a number of highly cyclical businesses
exposed to different demand drivers, makes it extremely difficult to forecast revenue development and profitability.
In order to address operational challenges and increase efficiencies Heraeus has initiated various restructuring programs over the
last few years, but we believe that “Heraeus FIT”, which was introduced in 2015, is much more comprehensive. It addresses the
company’s overall fixed cost structure as well as undertaking a more thorough re-organization of production and phasing out/
substitution of existing products. Restructuring costs related to this plan have negatively impacted profitability in 2015, but our base
case assumes that these will improve the company’s profitability and margins in the coming years. We expect the cash costs of these
restructuring measures to be spread over the next few years and be more than manageable in the context of Heraeus' FCF generation
and substantial cash balance.
CHALLENGING ECONOMIC CONDITIONS TO PERSIST, BUT SOME EASING EXPECTED TO SUPPORT IMPROVED EARNINGS AS OF 2016
In addition to the company's less focused product and geographical portfolio, the company’s weak profitability has also been driven
by weaker cyclical demand in some of the company's product segments. For example, the company has witnessed a structural
decline in its steel sensor business, increased substitution of gold bonding wire through copper palladium bonding wire (and where
its competitors have better market positions), which has negatively impacted the company's Electronics segment, but also sluggish
demand for sputtering targets used for hard disk drives in its industrial activities.
However, the company's photovoltaics is witnessing some improvement after several years of depressed demand and we expect
continued demand growth in the company's medical components as well in its quartz glass business, given the high levels of
investments in fiber optic networks. A more favorable product mix should also allow the company to moderately expand adjusted
EBITA as of 2016. We forecast adjusted EBITA should improve to around €263 million in 2016 and around €300 million in 2017.
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CORPORATES
Exhibit 2
Adjusted EBITA margin over non-pm revenues has been declining since peak in 2011
Source:Company information, Moody's
STRONG BALANCE SHEET AND LIQUIDITY PROFILE SUFFICIENT TO ABSORB EARNING PRESSURES
As at 31 December 2015 Heraeus had cash and cash equivalents of around €1.0 billion and adjusted net debt/EBITDA of 0.3x (-0.4x
on an unadjusted basis). This strong balance sheet combined with a conservative financial policy continues to support the company’s
Baa1 rating and the stable outlook. In particular, it provides the company with the financial means and time to undertake necessary
restructuring measures in order to improve the stability and growth of its earnings.
In addition, we forecast that improving profitability in 2016, continued focus on working capital management and a lower dividend
payout in 2016 will allow the company to generate Moody’s defined FCF in the range of €70 million to €90 million. This will further
strengthen the company’s liquidity profile in 2016.
Exhibit 3
FCF expected to continue to be volatile, but cumulative FCF contributes to stronger liquidity
Source: Company information, Moody's
Maintaining a strong cash balance is important, particularly in the context of the company’s earning pressures, as we consider Heraeus'
adjusted leverage of 3.4x in 2015 to be high in the context of the Baa1 rating level and compared with similarly-rated peers. We
currently forecast that Heraeus’ leverage will improve to around 3.0x in 2016 and at last around 2.5x in 2017, which we consider would
be at levels more commensurate for the rating level. Further improvements in earnings post 2016 as well as Heraeus’ outstanding €250
million bond, which falls due in May 2017, provide further scope for deleveraging in 2017 to this level.
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CORPORATES
We adjust Heraeus' reported debt for pension liabilities, operating leases and precious metal loans. However, precious metal loans in
the past have been volatile and add an additional element of uncertainty when forecasting the company's leverage metrics.
We believe the company’s commitment to a conservative financial policy is evidenced by the company’s strong liquidity profile, which
Heraeus has maintained since the sale of its dental business in 2013. On average the company has maintained a cash balance in excess
of €800 million since 2009 and operated a cash balance of around €1.0 billion over the last three years.
Heraeus also maintains a prudent dividend policy and a disciplined approach towards acquisitions. Heraeus’ dividend payout has
historically been around 25% and there have been no special dividends following the sale of the dental business back in 2013. We
also expect the company to remain moderate in terms of its acquisition spending and as in the past, engage in relatively small bolton acquisitions. Larger strategic acquisitions, if accompanied by still material operating underperformance, could place pressure on
Heraeus' current rating.
METAL TRADING RISKS ARE WELL MANAGED; TRADING OPERATIONS DISTORT FINANCIALS
Heraeus has substantial precious metal trading activities. These are used to hedge and physically secure precious metals needed for
the group's own manufacturing of its products as well as providing services to industry customers. Trading activities operate as a profit
center but risks are controlled given spot pricing, rigid trading limits and the close monitoring of counterparty risk. Risks from volatile
precious metal prices are typically borne by customers or hedged back-to-back.
The company's trading activities are inherently lower-margin as earning contributions reflect the charging of trading fees only. These
distort the company's overall group margins and therefore, in our view, EBITA margins calculated on a non-precious metals basis
are a better performance measure. While these continue to include contributions of the company's trading business they provide
greater insight into the profitability of the company's manufacturing activities. Revenues excluding precious metal content disregard
a substantial portion of the company’s COGS but at the same time allow monitoring of the company’s revenue growth independent
from fluctuations of precious metal prices which impact product revenues which the company reported up until 2014.
Heraeus also uses precious metal loans (PM loans) as a short-term financing tool. Within the loan transaction, Heraeus receives from
lenders (e.g. banks) a fixed quantity of precious metal for a certain period of time and in return pays interest for borrowing the precious
metal. We include these off-balance sheet PM loans in our adjusted gross debt figure. Depending on Heraeus' choice to directly use
cash to temporarily buy (hedged) precious metal or enter into PM loans, Heraeus faces higher working capital consumption in the first
case and higher adjusted debt in the latter case. In addition, volatility of precious metal prices affects group sales inventory level as well
as the absolute amount of PM loans.
Liquidity Analysis
We consider Heraeus' liquidity profile to be solid. As at December 2015, Heraeus had cash and cash equivalents of around €510 million
and marketable securities of around €485 million. Moreover, Heraeus maintains a €300 million syndicated credit facility, which was
undrawn as at 2015 and is expected to remain undrawn in 2016. This facility is set to mature in December 2020 (both two one year
extension options have been exercised). This is considered a strong source of liquidity since it contains neither financial covenants nor a
repeating MAC clause. Together with expected FFO generation these sources are more sufficient to accommodate unexpected swings
in working capital, capital expenditure needs, restructuring costs and short-term debt maturities of around €12 million as well as the
upcoming maturity of its outstanding €250 million senior notes in May 2017.
In addition, Heraeus benefits from a few bilateral credit facilities, the majority of which are not considered in our liquidity assessment
due to their short-term nature. Heraeus also has access to a €500 million commercial paper program, but given the company's healthy
cash balance, this is used infrequently.
Structural Considerations
Profile
Heraeus is a family-owned company, headquartered in Hanau, Germany, with around 12,500 employees. The company, founded
in 1851, is a leading provider of diversified high-value technological solutions in the markets chemical and metals, energy and the
environment, communications and electronics, health, mobility, and industrial applications. A large proportion of the products contain
or use precious metals, such as gold, silver and platinum metals in their production process.
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MOODY'S INVESTORS SERVICE
As of 1 January 2015, Heraeus has divided its Precious Metals and Material Technologies Business Groups to be more industry-focused
and will operate in a new management structure of 11 Global Business Units. These in turn report under five segments: Health;
Electronics; Environment; Industrial Applications; and Corporate.
In 2015, Heraeus generated revenues excluding precious metal (non-PM sales) of €1.9bn (2014: €1.8 billion) and around €13 billion of
total sales including its precious metal trading and the precious metal content of products sold. Up until 2014 the company reported
its product sales, which include precious metal content of products sold.
Heraeus is one of the top five industrial precious metal trading companies globally. Heraeus' trading division supplies its own
manufacturing processes but predominantly procures precious metals for customers, in which it charges a trading fee
Rating Methodology and Scorecard Factors
The principal methodology used in this rating was the Global Manufacturing Methodology published in July 2014. The grid-implied
rating for the year ending 31 December 2015 and the 12-18 months forward-looking grid indicate a Baa2 rating, one notch below the
current Baa1 rating. This is due to the scoring of the company's business profile, which is considered borderline with a Baa business
profile, and Heraeus' strong liquidity reserve, which is not factored into Moody's methodology rating grid. Heraeus' trading operations,
also negatively distort the company's operating margins. On a more meaningful Product Revenue only basis, the EBITA margin is
expected to remain in the high single-digit range, albeit we recognize the revenue scoring is also overstated by the company's trading
business.
Exhibit 4
Ratings
Exhibit 5
Category
HERAEUS HOLDING GMBH
Outlook
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15 July 2016
Moody's Rating
Stable
Heraeus Holding GmbH: Update to Key Credit Considerations
CORPORATES
MOODY'S INVESTORS SERVICE
Issuer Rating
Baa1
Source: Moody's Investors Service
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Heraeus Holding GmbH: Update to Key Credit Considerations
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MOODY'S INVESTORS SERVICE
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Heraeus Holding GmbH: Update to Key Credit Considerations