S&P Places Israel Chemical (ICL) Ratings on Review for Downgrade

S&P Global Ratings said that it has placed its 'BBB' corporate credit rating on fertilizer and specialty chemicals producer Israel Chemicals Ltd. (NYSE: ICL) on CreditWatch with negative implications. We also placed our 'BBB' ratings on the company's senior unsecured debt on CreditWatch negative.

The CreditWatch placement reflects the high likelihood that, due to weak market conditions, ICL's credit metrics will be below the level we view as commensurate with a 'BBB' rating in 2016 and 2017. We currently forecast an S&P Global Ratings-adjusted ratio of debt to EBITDA of 3.0x-3.5x in 2016, recovering to 2.5x-3.0x in 2017, which is weaker than our threshold for the current rating of 2.5x or below. The CreditWatch placement also reflects the potential that the various steps that have been and will be implemented by ICL's management could enhance its credit metrics and its overall financial standing.

The fertilizer market environment has weakened materially over the last few months. Consequently, we have revised down our forecasts for ICL's cash flow generation over the next two years. We consider that the price of potash has been under pressure because of an ongoing supply-demand imbalance, including the arrival of new capacity and inventory accumulation in major markets during 2015. In addition, until the recent recovery in crop prices, farmers' incomes were under pressure, which hampered their ability and willingness to acquire fertilizers.

ICL's average free-on-board (FOB) selling price per ton of potash in the first quarter of 2016 was $235, down from $280 in 2015. Although we expect potash price to remain relatively stable in the near future, we recognize that a key risk remains in the form of the additional industry capacity coming on stream in the next couple of years, notably from K+S, Eurochem, and other competitors.

Relatively low potash shipment volumes, particularly in China and India, weighed on ICL's operating performance in the first quarter of 2016. This was directly related to the high level of inventory and the delay of the 2016 contract with China, which is one of ICL's main markets and usually has significant influence on the general price dynamic for the entire industry. We expect potash shipment volumes to recover in the second half of the year, reaching 4.0 million-4.2 million tons by year-end 2016 and 4.2 million-4.5 million tons in 2017.

At the same time, ICL's debt increased in first-quarter 2016 on the back of the completion of the $450 million investment in a joint venture (JV) in China with phosphate producer Yunna Yuntianhua and purchase of 15% of its JV partner's shares. The new JV is engaged in mining phosphate rock and manufacturing, marketing, and distributing downstream phosphate products. The JV will provide ICL with access to vast reserves of low-cost phosphate rock and strengthen its position in the phosphate market, which we continue to view as positive. However, given the challenging market conditions and relatively low efficiency of the operation, we expect the contribution to EBITDA from the new joint venture to be limited in 2016 with a gradual increase in 2017 and 2018.

In reaction to challenging market conditions and in an attempt to reduce leverage, ICL has decided to implement several credit-enhancing measures, including modifying its dividend policy, cutting costs, and reducing capital expenditure (capex). Over the coming weeks, we will review management's plans to enhance ICL's credit metrics and its overall financial standing on top of the various steps ICL's management has already implemented.In our base case for ICL, we assume:

• An average FOB selling price per ton of potash of $230-$240 in 2016 and 2017.
• Total potash shipments volume of 4.0 million-4.2 million metric tons in 2016 and 4.2 million-4.5 million metric tons in 2017.
• Capex of $650 million in 2016 and 2017.
• A dividend payout of up to 50% of net profit.

Based on these assumptions, we arrive at the following credit measures:

• Adjusted FFO to debt of 20%-25% in 2016 and 25%-30% in 2017.
• Adjusted debt to EBITDA of 3.0x-3.5x in 2016 and 2.5x-3.0x in 2017.

We aim to resolve the CreditWatch within three months, once we have more information about management's actions to bolster credit quality. We will lower the ratings on ICL if our revised forecast continues to indicate that debt to EBITDA will remain higher than 2.5x and FFO to debt will remain below 35%, without near-term prospects of recovery. We could affirm the ratings if we conclude that management's actions are going to be sufficient to reduce leverage sufficiently or if industry conditions turn significantly more positive than we assume in our current base-case scenario.

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