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S&P cuts Norsk Hydro corporate credit ratings

Tuesday, Mar 24, 2009
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March 20 - Standard & Poor's Ratings Services said today it lowered to 'BBB-' from 'BBB' its long-term corporate credit rating on Norwegian aluminum producer Norsk Hydro ASA . At the same time, the short-term corporate credit rating was lowered to 'A-3' from 'A-2'. These actions are due to a sharp downturn in the aluminum sector, which we believe could lead to much weaker cash flow generation and leverage metrics in 2009. The ratings were removed from CreditWatch with negative implications, where they had been placed on Jan. 20, 2009. "In our view, Norsk Hydro will likely be unable to maintain its credit metrics in line with the previous 'BBB' rating. These include a ratio of funds from operations (FFO) to adjusted debt of 35%. Given the uncertainty about the depth and duration of the market downturn, the outlook is negative," said Standard & Poor's credit analyst Alex Herbert. The Kingdom of Norway (AAA/Stable/A-1+) is the company's largest and controlling shareholder, with a 43.8% stake (an additional 6.5% stake is held by the government pension fund). Norsk Hydro is a government-related entity, but we do not add a notch uplift to the corporate credit rating, because we do not believe that the state would provide extraordinary support. Nevertheless, we factor in ongoing support, including our view that the government is a stabilizing influence and likely to remain a supportive shareholder. "In our opinion, along with its peers, Norsk Hydro faces a very difficult market environment," said Mr. Herbert. Aluminum prices have fallen by almost 60% to about $1,400 per metric ton since a peak of about $3,300 in July 2008. Demand has declined in key end markets, including the construction and automotive sectors, and despite production cuts, inventories have risen to multiyear highs. On the basis of current aluminum prices, we anticipate that Norsk Hydro will report very weak profitability and cash flow generation during 2009. The company has substantial ongoing capital spending and investments planned for 2009, which, combined with much lower cash flows, will likely significantly weaken credit metrics, in our view. The group's performance will depend on the level of future aluminum prices and input costs as well as management's response to the downturn. The company has announced a range of corrective measures to adjust its business strategy and financial profile. These include cutting high-cost primary upstream production by 23% to about 1.3 million tons in 2009, suspending dividend payments, lowering working capital, and cutting costs through measures such as headcount reductions. However, capital expenditures will likely remain high in 2009, at about Norwegian krone (NOK) 3 billion, which, in our view, could further increase debt. In addition, the company plans further investments of about NOK4 billion in the 50%-owned Qatalum smelter joint-venture project in Qatar. We understand that Norsk Hydro plans to cut capital expenditures and investments by 40% in 2010, compared with the expected figure for 2009 (excluding investment in Qatalum). We estimate adjusted debt on Dec. 31, 2008 of about NOK17 billion, FFO of about NOK5 billion, and FFO to adjusted debt of about 30%. In our debt figures for the group, we make a number of major debt adjustments, including for pensions (NOK10.6 billion), operating leases (NOK2.1 billion), and surplus cash (NOK2.8 billion). In addition, we include Hydro's share of net debt in equity-accounted entities of about NOK4.9 billion, which mainly relates to the 50%-owned Qatalum smelter. As the Qatalum project requires further investment to be completed in 2009, Norsk Hydro's share of debt in this entity could rise quite markedly. We include these amounts in our debt adjustments, as we consider the entities to be of strategic importance, although we understand from Norsk Hydro that the debt is project finance, and nonrecourse in nature. The ratings on Norsk Hydro reflect our view of its position as the world's fifth-largest primary aluminum producer and the steps the company has taken to improve its cost position. However, the company faces a very difficult market environment, and likely much weaker credit metrics. The negative outlook reflects the possibility of a further downgrade during the next year or so, as a result of the continued high level of uncertainty about the depth and duration of the economic downturn, and the level of future aluminum prices and input costs. A ratio of FFO to adjusted debt of about 20% is consistent with the ratings; however, during 2009, Norsk Hydro could fall well below this level. We factor in negative free operating cash flow and higher adjusted debt, as a result of the harsh market environment and the group's ongoing high capital expenditures and investments planned for 2009. Nevertheless, we anticipate that Norsk Hydro's results will benefit in due course from the positive impact of the company's corrective measures. We believe that Norsk Hydro's management will continue to respond proactively to the downturn by cutting costs, lowering spending, preserving liquidity, and acting to protect credit ratios. We do not factor in debt-financed acquisitions. Ratings stability could be established if the group is able to sufficiently mitigate the impact of the market downturn through its corrective actions, and if market conditions improve. Downside pressure could increase if cash flow generation and leverage weaken below our expectations, or if management's response proves inadequate.

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