Fitch affirms Smurfit Kappa at 'BB'; revises outlook to positive

Sept 27 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has affirmed Smurfit Kappa (LSE: SKG.L - news) Group's (SKG) Long-term foreign currency Issuer Default Rating (IDR) at 'BB', and revised the Outlook to Positive from Stable. The agency has also affirmed the ratings of the related entities, Smurfit Kappa Acquisitions and Smurfit Kappa Treasury Funding, at 'BB'. A full list of the affected bonds is at the end of this release.

The affirmation reflects SKG's solid operating performance despite the weak economic environment in Western Europe. Effective cost-cutting measures and revenue growth and margin improvement in Latin America continue to support cash generation.

The Positive Outlook reflects Fitch's view that credit metrics will continue improving, with the funds from operation (FFO) gross leverage ratio expected to decline to below 3.5x over the next 18-24 months, or even earlier if the company decide to redeem part of the outstanding debt using available cash.

KEY RATING DRIVERS

Good Operating Performance

SKG's H113operating results continued to show a good performance, despite the sluggish economy in Western Europe, driven by solid growth in Latin America, which also benefits from the consolidation of Smurfit Kappa Orange County. Cash generation remained solid, with free cash flow (FCF) improving to EUR205m from EUR175m in H112, thanks also to lower interest costs.

Improving Outlook

While demand in Europe is likely to remain weak, the price trend is improving for the testliner (recycled-fibre cardboard), which showed some weaknesses in H212. Following a first price increase in H113, prices were back again to H112 levels. A further price hike was successfully implemented in Q313, which should benefit margins in H213. Market conditions remain positive for virgin fibre containerboard (Kraftliner), with prices remaining healthy and backed by solid demand.

Deleveraging Notwithstanding Acquisitions

Management's strategy is to allocate FCF to pay down debt or for acquisitions with the aim of maximising shareholders' value. While deleveraging was the absolute priority in past years, leverage is now back at a sustainable level allowing the company to revamp its external-growth policy, with the 2012 acquisition of Smurfit Kappa Orange County. Fitch believes that further external growth in Latam is possible. However, Fitch believes that SKG has sufficient financial flexibility to sustain mid-sized acquisitions, while continuing deleveraging. The agency estimates FFO gross leverage to improve to below 3.5x over the next 18-24 months.

Leading Position

SKG's ratings are further supported by its leading market positions, exposure to recession-resilient markets, and strong presence in Latin America. Vertical integration into containerboard gives some margin protection against raw material cost inflation.

RATING SENSITIVITIES:

Positive: Future (LSE: FUTR.L - news) developments that could lead to positive rating actions include:

The continuation of the current path in debt reduction and the improvement in credit metrics, with FFO adjusted leverage improving to below 3.5x, FCF/revenue remaining above 1% and FFO fixed charges coverage to improve to above 4.0x. Negative: Future developments that could lead to negative rating action include: A slowdown in the deleverage process, due to either a deterioration of the operating performance or to M&A activity, with FFO adjusted gross leverage remaining above 3.5x over the next 18-24 months could lead to a revision of the Outlook to Stable.

FULL LIST OF RATING ACTIONS

Smurfit Kappa Group

Long-term foreign currency IDR affirmed at 'BB', Outlook revised to Positive from Stable

The following instruments' ratings have been affirmed at 'BB':

Smurfit Kappa Acquisitions

Senior unsecured bank facility due 2018

EUR500m notes due 2017

EUR200m and USD300m notes due 2018

EUR500m notes due 2019

EUR400m and EUR250m notes due 2020

Smurfit Kappa Treasury Funding

USD292m notes due 2025