S&P Downgrades CF Industries (CF) Ratings to Junk

S&P Global Ratings said today that it lowered its corporate credit rating and issue-level ratings on CF Industries Inc. (NYSE: CF) to 'BB+' from 'BBB-'. The outlook is negative. At the same time, we assigned recovery ratings to the company's unsecured debt of '3', indicating our expectation for meaningful recovery (lower end of the 50%-70% range) in the event of a default.

The lower ratings reflect our view that ongoing depressed pricing in the nitrogen fertilizer sector will weaken credit metrics to levels that are not appropriate at the previous ratings. Pricing in the second half of 2016 has been weaker than our previous assumptions. We do not anticipate any meaningful pricing recovery in 2017, though seasonal variations could result in temporary improvement. Our current view is that lower prices will cause credit metrics to be appropriate at the reassessed financial risk profile of significant. We anticipate that the ratio of funds from operations to total debt will be 20% or higher on a five-year weighted average basis (including two years of historical numbers). We believe that the ratio will be meaningfully lower than 20% at year-end 2016, improving in 2017 in part from additional capacity at CF. Our previous expectations were for this ratio to be 30% or higher on a weighted-average basis. Our current view is that pricing will recover in 2018, though CF is unlikely to return to the high adjusted EBITDA levels achieved in 2014 of over $2 billion or the nearly $1.9 billion in 2015. Our anticipation is that some volume increases in 2017 will result in adjusted EBITDA slightly below $1.5 billion, with further improvement in 2018 as pricing improves.

The company's strength as the largest domestic nitrogen fertilizer producer continues to contribute to our assessment of the business risk profile as satisfactory. We do not believe that the company's business risk profile has changed despite ongoing pressure on pricing, as key long-term demand fundamentals and the North American low-cost advantage remain key business strengths. We continue to view the company at the lower end of the satisfactory assessment relative to peers, a view that contributes to the downgrade because we pick the lower end of the 'BBB'/'BB+' outcome that the company's business risk profile and financial risk profile map to. Our assessment of the business risk profile incorporates volatility in pricing and demand that we view as characteristic of the sector. Our view remains that CF will benefit from competitively priced domestic natural gas, which has already improved the cost position of U.S.-based nitrogen fertilizer producers relative to imports. We view capacity expansions in 2016 at two existing facilities will likely allow CF to take market share from nitrogen imports. We anticipate steady North American fertilizer demand in 2017 but see low prices
hurting profitability through most of the year. Key risks include the company's narrow focus on a commodity fertilizer; geographic concentration in U.S. and Canadian markets, a risk given our outlook on the sector for 2016 and 2017; and asset concentration with a large portion of production from a single location, in Donaldsonville, La.

We have lowered our assessment of financial risk to significant from intermediate because of our diminished expectations for credit metrics. We assume the company will be committed to maintain credit quality and do not anticipate the company will pursue future shareholder rewards, growth plans, or acquisitions such that they increase leverage levels beyond our range of expectations.

We assess CF's liquidity to be strong, with sources to exceed uses by more than 1.5x. Liquidity sources minus uses should remain positive even if EBITDA is 30% less than we project. Our assessment anticipates that CF will remain proactive in amending covenants in the light of a weaker than anticipated operating environment, so that it has ongoing access to its credit facilities and debt. In the third quarter of 2016, the company negotiated an amendment to covenants on its debt.

Principal liquidity sources:

• Cash on hand of about $2 billion as of June 30, 2016.
• Substantial availability under the revolving credit facility.
• Cash funds from operations averaging approximately $1 billion annually for the next two years.

Principal liquidity uses:

• Scaled down capital expenditures of less than $500 million in the next year, at a minimum. Capex in previous years were at elevated levels above $2 billion as a result of the company's large expansion plans.
• Seasonal working capital requirements of around $750 million.
• Dividends, including distributions to non-controlling interests, of about $400 million per year.

The negative outlook reflects our expectation that CF Industries Inc.'s credit measures will be strained for the ratings over at least the next 12 months. We do not believe the company will pursue future shareholder rewards, growth plans, or acquisitions such that they increase leverage levels beyond our range of expectations, with the exception of a temporary dip during periods of peak capital spending. Specifically, we expect credit measures to be weak for the ratings during 2016 when we observe the impact of cash deployed for expansions without the incremental EBITDA from these projects, and again in 2017 when new capacity additions will contribute to keeping prices low. We expect that capital spending will be reduced in 2017, following several years of elevated growth capex.

We could lower the ratings over the next 12 months if operating performance weakens unexpectedly or debt rises such that the weighted average ratio of adjusted debt/EBITDA is consistently above 4x, and an FFO to total debt of below 20% with no prospect for improvement. We anticipate the ratio of funds from operations to total debt will be above 20% on a weighted-average basis but believe this ratio will be below 20% in 2016, approach 20% in 2017, and exceed 20% in 2018, and strengthen beyond 2018. A weakening of these ratios to levels below expectations could happen through several combinations of revenue and margin deterioration, including a sharp decline in revenues or a sustained decrease in EBITDA margins by a few percentage points each year relative to our expectations. We believe that the sector remains susceptible to unexpected event risks. If management, against our expectation, stretches the financial profile to pursue additional growth objectives or shareholder rewards, any operating setback could be exacerbated and contribute to a potential weakening of metrics, which could result in a downgrade. We could also lower ratings if there are major operational risks that arise from bringing on new expanded capacity at the company's existing plants.

We could revise the outlook to stable over the next 12 months if earnings and cash flow prospects improve markedly in 2017 relative to our expectations, so that we believe the company's FFO/TD ratio could exceed 20% at year-end 2017. An improvement in EBITDA margins could result in stronger-than-anticipated credit measures.

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