S&P Raises OUtlook on Cabot Corp. (CBT) to Stable; Cites Improving Performance, Debt Reduction

Standard & Poor's Ratings Services said it revised its outlook on Cabot Corp. (NYSE: CBT) to stable from negative. We also affirmed all of our ratings on the company, including the 'BBB+' corporate credit rating.

The outlook revision reflects our expectation that steadily improving operating performance and gradual debt reduction should allow the company to continue to strengthen credit measures to levels that are at the higher end of the "intermediate" financial risk profile band. In April 2014, the company received the final $215 million in proceeds from the divestiture of its supermetals segment, which were used to reduce debt in the June quarter. We believe this reflects management's continued commitment to restoring its financial profile following the 2012 acquisition of Norit (reported as the purification solutions segment) and expect that the company will maintain adjusted debt to EBITDA at about 2x. We expect that management will remain prudent in regards to growth initiatives and shareholder rewards, and our base case does not factor in any meaningful increases in debt to fund acquisitions or share repurchases.

"The stable outlook reflects our belief that the company will continue to improve its profitability over the next one to two years, given our expectation for moderate demand growth in the company's key end markets," said Standard & Poor's credit analyst Daniel Krauss. "A key underpinning at the rating is our expectation that the implementation of Mercury and Air Toxic Standards starting in April 2015 will help to moderately boost the company's EBITDA."

Our ratings assume management will remain committed to improving credit measures, and will use free cash flows for a balance of debt reduction, shareholder rewards, and growth initiatives. We believe the company's recent use of the $215 million in proceeds from the supermetals divestiture to reduce debt, reflects the company's commitment to maintaining financial policies and a financial risk profile appropriate for the current rating.

We would lower the ratings by one notch in the near term if a more challenging macro environment caused us to believe credit metrics would not improve, or would deteriorate from current levels. This could result if weakness in the tire market caused revenue growth to stall or turn negative, or if the expected pickup in the purification solutions segment fails to materialize. Based on our downside scenario, we could consider a lower rating if revenues remained flat, coupled with a 200 basis points or more reduction in EBITDA margins. As a result, we would expect debt to EBITDA of above 2.5x and FFO to debt of about 30%. We could also lower the ratings if, against our expectations, the company increased leverage to fund acquisitions or shareholder rewards, and it became clear that management was not committed to maintaining credit measures appropriate for the current rating.

We regard an upgrade as unlikely during the next two years, as we believe that the company's business risk profile is unlikely to improve to what we consider to be a "strong" assessment, given its focus on carbon black and exposure to cyclical end markets. To consider a higher rating, we would have to see credit measures at the stronger end of the "modest" band, which includes FFO to debt of between 45% to 60% and adjusted debt to EBITDA of 1.5x to 2x, and gain comfort that management was committed to maintaining those credit measures. Given some of the company's growth initiatives and the potential for shareholder rewards, we view the possibility of an upgrade as remote.

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