(The following statement was released by the rating agency) Fitch Ratings-Chicago-April 22: Fitch Ratings has affirmed the ratings of James Hardie International Group Limited (James Hardie) and its subsidiaries, including the company's 'BBB-' Issuer Default Rating. The Rating Outlook has been revised to Negative from Stable. The Negative Outlook reflects the significant business interruption from the coronavirus pandemic and the implications of a downturn in construction spending that could extend into 2021. Fitch's rating case includes expectations for a deep global recession in 2020, followed by a recovery thereafter. Fitch anticipates a sharp increase in total debt/operating EBITDA to above 4.5x at the end of James Hardie's fiscal year 2021 (ending March 31, 2021) from 2.8x for the LTM period ending Dec. 31, 2019. The Fitch-calculated leverage of above 4.5x at FYE 2021 takes into account Fitch's forecast of an elevated asbestos payment to the AICF as a result of the company's projected strong cash flow generation during FY 2020. Leverage is projected to decline to around 2.9x by FYE 2022 as demand recovers and margins improve. The Negative Outlook also incorporates the uncertainties surrounding the depth and duration of the operational and demand disruption from the coronavirus pandemic, which adds to the risk that the company may not be able to lower leverage to below 3.0x by FYE 2022. Fitch expects liquidity will be sufficient through the period of lower revenues and margins. A delayed recovery beyond 2021 or the company being more aggressive with acquisitions and/or capital expenditures that results in negative free cash flow and leverage sustaining above 3.0x could lead to a downgrade. Key Rating Drivers Coronavirus Impact: Fitch expects significant decline in revenues and margins across James Hardie's businesses and geographies. While the overall impact of the coronavirus pandemic is difficult to determine at this time, Fitch's rating case assumes year-over-year organic revenue declines of 40% in 1Q21 (ending June 30, 2020), 30% in 2Q21 and continued weakness during 2H21, resulting in full-year revenue contraction of about 20%-25% in FY 2021. Fitch anticipates EBITDA margins (excluding asbestos payments) to fall 300-350 bps during FY 2021 due to lower operating leverage. The rating affirmation reflects Fitch's expectation that demand picks up starting in the company's 1Q22 through the remainder of FY 2022, resulting in low-double digit revenue growth and EBITDA margin expansion of 200-250 bps in FY 2022. Elevated Leverage: James Hardie's leverage has improved after increasing in FY 2019 following the acquisition of Fermacell and weaker margins from raw material cost inflation. Fitch-calculated leverage, as measured by total debt/operating EBITDA (less asbestos payments), improved to 2.8x for the LTM period ending Dec. 31, 2019 from 3.2x at FYE 2019. Fitch anticipates leverage will spike to above 4.5x at FYE 2021 before declining to 2.9x at FYE 2022, which Fitch views as appropriate for James Hardie's 'BBB-' IDR. Growth Strategy: The company has grown meaningfully in recent years from capacity expansion and the acquisition of German-based XI (DL) Holdings GmbH and its subsidiaries (including Fermacell GmbH) for EUR473 million. Fermacell is Europe's number one fiber gypsum board manufacturer, with more than 70% share of the fiber gypsum category, which is a small part of the overall dry lining wall market, and also produces cement-bonded boards. The acquisition of Fermacell provides James Hardie with a platform to eventually grow its fiber cement business in Europe. James Hardie also increased investment in its existing manufacturing capacity during the past few years to meet demand, including capital spending of about $301 million during FY 2019 (ending March 31) and continued elevated capital spending totaling about $200 million planned for FY 2020. Fitch expects the company will continue to invest in its manufacturing network, although capital spending will be lower in FY 2021 and FY 2022 as demand weakens. In the past, James Hardie has shown discipline in managing capital expenditures and Fitch expects this to continue. Fitch expects James Hardie will be slightly FCF positive in FY 2020 and generate 2%-3% FCF margin in FY 2021 and FY 2022. Leading Market Position: James Hardie is a world leader in manufacturing fiber cement siding and backerboard. Based on net sales, the company believes it is the largest manufacturer of fiber cement products and systems for internal and external building construction applications in the U.S., Australia, New Zealand and the Philippines. Within the U.S., James Hardie believes it has about 90% market share in the fiber cement exterior siding segment. However, the company competes with alternative siding products, including vinyl and wood siding as well as bricks, stucco and engineered wood products. Fiber cement accounted for about 20% of exterior wall material of new single-family houses completed in 2018, flat compared with the previous years but meaningfully higher than the 9% share reported in 2005. This positions the company to gain share within the broader exterior siding market from other siding products. The Fermacell business also adds a category leader with strong brand recognition in key regions in Europe. Geographic, Product and End-Market Diversity: Following the acquisition of Fermacell, the sale of fiber cement products in North America declined to about 69.4% of total revenues during the first nine months of FY 2020 compared with 76.4% during the same period in FY 2018. Within the U.S., the company estimates that about 60% of sales are directed to the less volatile repair and remodel segment, while 40% are directed to new home construction. Fiber cement sales to the Asia Pacific region accounted for about 16.7% of YTD sales. The acquisition of Fermacell, which increased the company's revenues in Europe from EUR31 million to more than EUR325 million on an LTM basis, expanded the company's operations in this region and accounted for 13.9% of YTD sales, up from less than 2% in FY 2018. Although still heavily exposed to the U.S. housing market, the growth of the company's operations overseas somewhat tempers the effect of regional downturns. The acquisition of Fermacell also added fiber gypsum boards and cement-bonded boards to James Hardie's product offerings. Nevertheless, James Hardie has a narrow product offering, especially when compared with its other investment-grade building products peers. Asbestos Payments/ESG Influence: James Hardie has an ESG Relevance Score of 4 for Customer Welfare due to exposure to asbestos related liabilities, which has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors. James Hardie is required to make payments to the Asbestos Injuries Compensation Fund (AICF), a special purpose fund that provides compensation for Australian asbestos-related personal injury and death claims for which certain former James Hardie companies are liable. The agreement requires the company to contribute up to 35% of its operating cash flow to the fund. Between 2007 and 2019, James Hardie has contributed AUD1,350.1 million to the AICF, including $108.9 million paid to the fund in July 2019. Fitch does not include the asbestos liability as debt in calculating James Hardie's financial ratios. However, Fitch subtracts the actual annual cash outflow (paid to the AICF) in its calculation of operating EBITDA. James Hardie's FFO and FCF measures are also reduced by the asbestos payments. Fitch believes that this method of treating the liability and the cash outflow best represents the risk associated with this contingent liability. Derivation Summary James Hardie's ratings reflect its dominant market position within the fiber cement industry and strong position in the U.S. exterior siding market, relatively diversified geographic and end-market diversity, and conservative financial strategy. Risks include the cyclicality of the company's end markets, somewhat aggressive (although disciplined) growth strategy, some customer concentration, relatively narrow product offering, and exposure to asbestos liabilities. James Hardie's leverage metrics, including total debt/operating EBITDA of 2.8x, are weaker than other 'BBB-' rated building products issuers, including Owens Corning (BBB-/Stable) and Masco Corporation (NYSE:MAS) (BBB-/Positive). James Hardie also has lower revenues, lesser FCF, and narrower product offering compared to its low-investment grade peers, but has better EBITDA margins Key Assumptions Fitch's Key Assumptions Within Its Rating Case for the Issuer -- Revenues decline 20%-25% in FY 2021 and increase 11%-12% in FY 2022. -- EBITDA margins (before asbestos payments) fall 300-350 bps in FY 2021 and improve 200-250 bps in FY 2022. -- Total debt/operating EBITDA (after asbestos payments) of about 4.6x at FYE 2021 and 2.9x at FYE 2022. -- FCF margin of 2%-3% during fiscal years 2021 and 2022. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action -- The Outlook may be revised to Stable if Fitch gains confidence the severity and duration of the coronavirus pandemic will not inhibit James Hardie's ability to return total debt/operating EBITDA to 3.0x or lower. -- The company's rating is constrained by the company's size and narrow product offering. -- Positive rating actions may be considered if the company diversifies its product offerings and further grows its revenues. These, combined with maintenance of strong credit metrics (including Fitch-calculated total debt/operating EBITDA consistently below 2x, FFO leverage sustained below 2.5x and EBITDA/interest paid above 10x), management's continued adherence to a disciplined capital allocation strategy, and no material change in the company's obligations to fund its asbestos liabilities, could result in positive rating actions. Developments That May, Individually or Collectively, Lead to Negative Rating Action -- Sustained erosion of profits and cash flow due to meaningful and continued loss of market share and/or sustained materials and energy cost pressures that contract margins, leading to weak credit metrics, including total debt/operating EBITDA sustained above 3.0x and FFO leverage consistently exceeding 3.5x, and EBITDA/interest paid below 7.0x. -- Significant decline in available liquidity resulting from inability to borrow under its revolving credit facility and/or consistent negative FCF generation. -- Fitch will also review the ratings if there is a meaningful change in its obligations to fund its asbestos liabilities or if new, meaningful claims arise from other jurisdictions. Best/Worst Case Rating Scenario International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579. Liquidity and Debt Structure Good Liquidity James Hardie has good liquidity with $148.9 million of cash and $320 million of borrowing availability under its $500 million revolving credit facility that matures in December 2022. The size of the facility may be increased by up to $250 million through an accordion feature, subject to lender commitments. The company's revolving credit facility has a leverage covenant requirement of net debt to EBITDA not to exceed 3.0x. The covenant leverage ratio is calculated differently relative to Fitch's leverage ratio calculation and does not adjust for the asbestos payment to the AICF. Given Fitch's expectation for meaningful revenue and profitability declines, there is risk that the company may breach its leverage covenant and will not have access to its revolver. The rating affirmation incorporates Fitch's expectation that James Hardie will be in compliance with its leverage covenant or is able to obtain a temporary waiver from its lenders. A meaningful decline in liquidity could result in a downgrade. Debt Maturities The company's debt maturities are well-laddered, with the next major debt maturity occurring in January 2025, when $400 million of senior notes become due. The next maturity is in 2026, when the company's EUR400 million sr. notes mature. Summary of Financial Adjustments Fitch does not include James Hardie's asbestos liability as debt in calculating the company's financial ratios. The company's EBITDA is lowered by the amount of annual asbestos payment made by James Hardie to the AICF during the year. Fitch also excludes non-recurring costs and expenses, including acquisition and integration costs and product discontinuation costs. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations James Hardie has an ESG Relevance Score of 4 for Customer Welfare due to exposure to asbestos related liabilities, which has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors. For more information on our ESG Relevance Scores, visit https://www.fitchratings.com/esg. James Hardie International Group Ltd.; Long Term Issuer Default Rating; Affirmed; BBB-; RO:Neg James Hardie International Finance DAC; Long Term Issuer Default Rating; Affirmed; BBB-; RO:Neg ----senior unsecured; Long Term Rating; Affirmed; BBB- James Hardie Building Products, Inc.; Long Term Issuer Default Rating; Affirmed; BBB-; RO:Neg Contacts: Primary Rating Analyst Robert Rulla, CPA Senior Director +1 312 606 2311 Fitch Ratings, Inc. One North Wacker Drive Chicago 60606 Secondary Rating Analyst Jonathan Boise, Director +1 212 908 0622 Committee Chairperson Philip Smyth, CFA Senior Director +1 212 908 0531
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