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Rating action

Scope Ratings GmbH (Scope) has today affirmed the BBB issuer rating of Norwegian commodity focused chemical company Elkem and revised the Outlook to Negative from Stable. Elkem‘s senior unsecured debt rating has been affirmed at BBB and Elkem’s short term debt rating is affirmed at S-2.

Rating rationale

The rating action reflects the larger-than-expected deterioration in both revenue and profitability so far in 2023 and the prospects of a prolonged economic slowdown in the company’s main territories (China and EU) and end-markets (Construction and Automotive). This would likely result in sustained lower prices on silicon based products which directly impacts Elkem’s profitability, thereby applying pressure on Elkem’s interest cover covenant and/or prevent Elkem from returning its leverage to its stated financial policy range of 1x-2x within the cycle.

Emphasising the through-the-cycle approach of Scope’s Chemicals Rating Methodology, the financial risk profile is affirmed at BBB+ despite being weaker than last year. Declining commodity prices so far in 2023 has led to a decline in Elkem’s profitability and a deterioration in credit metrics, as exemplified by a LTM Q3 2023 Scope-adjusted debt/EBITDA of 1.6x and an EBITDA/interest of 12x, which is significantly weaker than at end-2022 (0.2x and 48.2x, respectively). Following continued weak demand and low commodity prices in Q4 2023 Scope expects a further weakening at end-2023, with Scope-adjusted debt/EBITDA increasing to 2.5x and EBITDA/interest falling to 7.7x. Leverage will likely remain at such levels for 2024 before potentially recovering within Elkems stated 1-2x leverage target for 2025. Weaker profitability paired with increasing cost of debt is also projected to put pressure on the company’s historically strong interest coverage ratio, with a decline to 5.6x at end-2024 before improving to 9.6x in 2025. On a 12-month basis Scope sees some pressure on Elkems 4.0x interest cover covenant. Should relevant commodity prices drop below our estimates for 2024 this could pose a risk. In that instance, we expect Elkem to proactively obtain a waiver and that its strong liquidity position as of Q3 2023 (unrestricted cash and unutilised facilities totaling NOK 13.2bn) acts as a mitigant.

Considering Elkem’s financial target of leverage between 1x-2x, Scope expects the company to significantly reduce strategic investments and not conduct larger M&As as long as the market remain difficult, to bring leverage down again within the cycle. However, Scope expects high investments for 2023 as already initiated projects are finalised in H2 2023 and H1 2024. Scope also considers it likely that smaller bolt-on acquisitions could occur, as exemplified by the 2022 acquisition of Belgian refractories company KeyVest and the 2023 acquisition of Slovakian producer of carbon materials, VUM.

High dividends and high tax payments based on 2022’s record performance has produced negative cash flow in 2023. This has in part been cash funded, as exemplified by net interest-bearing debt (including financing in China) increasing from NOK 3bn at end-2022 to NOK 8.7bn by the end of September 2023. However, Scope expects cash flows will improve in 2024 and 2025.

Elkem’s liquidity remains adequate, given the company’s sound internal and external liquidity coverage, exemplified by around NOK 7.5bn in unrestricted cash and EUR 500m in unutilised committed facilities compared to an estimated NOK 900m in maturities in Q4 2023 and NOK 2.3bn in 2024.

Elkem’s business risk profile, affirmed at BBB-, continues to reflect Elkem’s position as an integrated player in the global silicone industry, its strong cost position and good global footprint with 31 production facilities across the globe. However, as highlighted in previous ratings, Elkem’s lower contribution of specialty-like products to sales, higher share of cyclical end-markets and dependence on commodity prices remain the main factors hampering Elkem’s business risk profile. These factors came into play towards the end of 2022, as the company’s Silicones division started reporting declining profitability, following decreasing commodity prices and a weakening economic outlooks, particularly in China. This decline was expected and highlighted in last year’s assesment, as the prices observed in 2021-2022 were deemed unsustainable over time. As 2023 has shown, the decline turned out to be sharper than expected, as industries catered to by Elkem was directly impacted by inflated costs and rising interest rates, such as construction and automotive. In addition, new production capacity initiated in 2021-2022 has entered the market in 2023, putting further downward pressure on prices. Consequently, Elkem reported below-historical-average performance for 9M 2023, as exemplified by an EBITDA margin of 12.5%. Driven by a negative EBITDA contribution from its Silicones division, declining EBITDA contribution from its Silicon Products division and partly mitigated by good performance in its Carbon Solutions division. Scope expects that the latter two divisions will drive revenue and EBITDA in the short to medium term. In sum, Scope expects EBITDA margins of 10.2%-14.1% in the medium term but highlights the importance of looking through the cycle when assessing commodity-focused chemicals companies.

Elkem's financial policy upholds sound principles, with a declared leverage target range of 1.0x to 2.0x and a dividend payout ratio of 30% to 50% of group profits. However, it is noteworthy that the company has exhibited tolerance for multi-year deviations from these targets, as evidenced by leverage figures exceeding 2.0x in both 2019 and 2020.

Regarding parent support, Elkem is majority-owned by Bluestar, resulting in an indirect ownership by the Chinese government through the ChemChina/Sinochem holding companies. Scope makes no adjustments for this ownership but acknowledges the proven cooperation between Elkem and its direct parent company.

Environmental, social and governance factors have no impact on the rating, and none are specific to the company at this stage.

Outlook and rating-change drivers

The Negative Outlook reflects the larger-than-expected deterioration in both revenue and profitability so far in 2023 and the prospects of a prolonged economic slowdown in the company’s main territories (China and EU) and end-markets (Construction and Automotive). This would likely result in sustained lower prices on silicon products which directly impacts Elkem’s profitability, thereby applying pressure on Elkem’s interest cover covenant and/or prevent Elkem from returning its leverage to its stated financial policy range of 1-2x within the cycle.

A downgrade could occur if Scope-adjusted debt/EBITDA stayed at 2.5x or above longer than forecasted, possibly from a prolonged economic downturn in key markets and/or lower than projected commodity prices.

A positive rating action, as expressed by return to a Stable Outlook is possible if Scope-adjusted debt/EBITDA recovers below 2.5 in a timely manner.

Further ratings upside is deemed remote but could be possible if Scope-adjusted debt/EBITDA went below 1.0x, sustained. In the long term, a positive rating action could also occur if overall business risks improved through a higher specialty chemicals exposure or an improved competitive position.

Long-term and short-term debt ratings

Elkem ASA is the bond-issuing entity, and the senior unsecured rating has been affirmed at BBB, in line with the issuer rating.

The S-2 short-term rating has also been affirmed and continues to reflect the company’s sufficient short-term internal and external debt coverage paired with good access to banks, including to undrawn credit facilities, as well as equity and debt markets.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and/or Outlook, (General Corporate Rating Methodology, 16 October 2023; Chemicals Rating Methodology, 17 April 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlook and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings and/or Outlook were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Michael-Marco Simonsen, Associate Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 17 December 2021. The Credit Ratings/Outlook were last updated on 21 December 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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