S&P Lowers Outlook on Kraton Performance Polymers (KRA) to Stable; Notes 'Weak' Business Risk Profile

Standard & Poor's Ratings Services revised its outlook on Kraton Performance Polymers (NYSE: KRA) to stable from positive. At the same time, we affirmed our 'B+' corporate credit rating on the company and our 'B' issue-level rating on the company's unsecured debt. The recovery rating on the unsecured debt remains '5', indicating our expectation of modest (10% to 30%) recovery in the event of a payment default.

"Following the termination of the agreement to combine Kraton's assets with LCY Chemical Corp.'s sytrenic block copolymers [SBC] assets, which could have led to higher earnings with no additional debt, Kraton's financial risk profile will not improve to levels that would warrant a higher rating in the near term," said Standard & Poor's credit analyst Pranay Sonalkar. The stable outlook reflects our view that Kraton can continue to pass through changes in raw material costs in a timely fashion. We also expect that the construction of the plant at the joint venture with Formosa will continue as planned and remain within budget.

Our ratings on Kraton reflect our assessment of the company's "weak" business risk profile and "aggressive" financial risk profile. The company is narrowly focused on styrenic block copolymers (SBCs), vulnerable to sharp raw material cost fluctuations, and exposed to cyclical and seasonal demand patterns for products serving roofing, paving, auto, and electronics markets. These negative factors are balanced by Kraton's ongoing efforts to maintain favorable pricing relative to raw material cost fluctuations, good end-market and geographic diversification, and improved operating efficiency in recent years.

Kraton is a leading producer of both unhydrogenated and hydrogenated SBCs (USBCs and HSBCs, respectively). We expect the company's product mix to continue shifting to higher value products, including HSBCs (used in personal hygiene, medical products, automotive components, and soft-grip handles) and polyisoprene rubber and polyisoprene latex (used in surgical gloves and
condoms).

The stable outlook reflects our expectation that Kraton can continue to pass through changes in raw material costs in a timely fashion. We expect debt levels to increase somewhat as a result of a 50/50 joint venture with Formosa Petrochemical Corp. to build, own, and operate a manufacturing plant in Taiwan.

In the longer term, we expect moderate sales growth, particularly in specialty applications and end markets. We expect that the company will improve operating cash flow to debt to above 17% and maintain total adjusted debt to EBITDA at below 4x well within our target of above 10% and below 5x respectively for the current rating.

We could raise the rating by a notch if the company is able to successfully execute on its joint venture with Formosa and improve its EBITDA margins on a sustainable basis by 300 basis points. In this scenario, we believe operating cash flow to debt would remain above 25% and leverage would remain below 3x for an extended period.

We could lower the ratings if weaker-than-expected economic conditions, higher-than-anticipated raw material costs, or more-competitive market conditions cause operating cash flow to debt to drop below 10% without prospects for recovery. Under our current capital expenditure and debt assumptions, we believe revenues would have to decline by about 5% and EBITDA margins would have to decline 350 basis points for this to occur. We could also lower ratings in the face of significant challenges at the Formosa joint venture or debt-financed acquisitions, or in the unlikely event of sizable shareholder rewards.

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