TEXT-S&P cuts Novelis Inc to 'B+' on weak cash flow

July 15 - Standard & Poor's Ratings Services today said it lowered its long-term corporate credit rating on Novelis Inc. to 'B+' from 'BB-'. At the same time, we lowered the rating on the company's senior secured term loan one notch to 'BB-'. The recovery rating of '2' on the loan is unchanged. We also lowered the rating on the company's senior unsecured notes a notch to 'B-' The '6' recovery rating on the notes is unchanged. We also removed the ratings from CreditWatch with negative implications, where they were placed Feb. 20. The outlook is stable. (For the complete corporate credit rating rationale, see the research report to be published on RatingsDirect immediately following this media release.) "The company's profitability and cash flow remain weak, exacerbating its heavy debt burden," said Standard & Poor's credit analyst Donald Marleau. Incorporated in this rating action is our belief that the credit quality of the company's parent, Hindalco Industries Inc. (not rated), has weakened. The rating action also reflects its lower earnings stemming from the drop in primary aluminum prices, as well as its heavy debt load and significant capital expenditure plans. "In our opinion, the ratings on Novelis reflect the company's poor cash generation, high debt leverage, and unstable operating earnings," Mr. Marleau added. Alleviating these weaknesses are the company's leading position in the global aluminum rolled products market, and extensive geographic and product diversity. The ratings also reflect the links to Hindalco, for which Novelis is a long-term, strategically important investment. Novelis' EBITDA at March 31, 2009, belies its weak cash flow. Revenues and EBITDA currently overstate the company's cash generation, as it amortizes the fair value of capitalized can-price ceiling liabilities into revenue in the wake of its acquisition by Hindalco. As such, a significant gap has emerged between EBITDA and other measures of funds flow, making recent historical EBITDA-based metrics unrepresentative of actual credit quality. Despite good working capital management that has been a source of cash, weak funds from operations has contributed to negative discretionary cash flow in each of the past three years. That said, we expect that cash flow metrics will begin to improve, albeit slowly, considering the difficult economic fundamentals the company faces. Weak economic conditions have caused lower sales volumes, with shipments of flat rolled products decreasing 7% for fiscal 2009. Most of the decline came in the second half of the year from the automotive, construction, and industrial segments, which account for less than half of Novelis' shipments; can sheet shipments remained stable. The outlook is stable. The ratings on Novelis are a function of the company's persistently high debt burden, as well as our views of Hindalco's credit quality and expectations of parental support. We believe that Novelis' cash flow will improve modestly during the coming 12-18 months, as cost reductions offset lower volumes and the company's earnings begin to translate into a steadier stream of operating cash flow. Given that aluminum prices remain stable at a decidedly lower level than in recent years, we believe that Novelis could begin generating cash from operations commensurate with its reported EBITDA. We could revise the outlook to negative or lower the ratings if the company turns free cash flow negative (excluding seasonal and price-related working capital swings), thereby increasing its debt burden and weakening liquidity. On the other hand, we would consider revising the outlook to positive if Novelis began reducing debt from a more stable stream of free cash flow, thus improving FFO-to-debt to more than 20%. Complete ratings information is available to RatingsDirect subscribers at www.ratingsdirect.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com; select your preferred country or region, then Ratings in the left navigation bar, followed by Find a Rating. Primary Credit Analyst: Donald Marleau, CFA, Toronto (1) 416-507-2526; donald_marleau@standardandpoors.com (New York Ratings Team)