Fitch Ratings has affirmed Bakelite US Holdco, Inc's Issuer Default Rating (IDR) at 'BB'.

Fitch has also affirmed the rating of Bakelite's term loan at 'BB+'/'RR2'. The Rating Outlook remains Stable.

Bakelite's 'BB' rating reflects the company's leading market share in formaldehyde-based resins in both North America and Europe, meaningful barriers to entry and its attractive pricing mechanism that allows for raw material price pass-through. These strengths are tempered by the company's exposure to the cyclical construction and automotive end markets and exposure to formaldehyde and phenol.

The Stable Outlook considers Fitch's expectation Bakelite's leverage will return to below 4.0x by 2025 after remaining above that level in 2023 and 2024, as the company's construction and European exposure will likely weigh on its results in the short term. Additionally, Fitch expects that Bakelite will generate positive FCF over the ratings horizon through working capital release, moderate capex requirements and a manageable debt burden.

Key Rating Drivers

Expected Near-Term Weakness: Fitch expects Bakelite's EBITDA leverage to exceed 4.0x in 2023 and 2024 should a downturn materialize, as the company's exposure to home construction/remodeling (approximately 54% of gross profit) and Europe (approximately 33% of gross profit) will likely weigh on its results. Nevertheless, Fitch expects that Bakelite's EBITDA leverage will fall below the 4.0x threshold by 2025. However, prolonged weakness in these key markets could pressure Bakelite's ratings.

High Barriers to Entry: The resins sold in this industry are typically developed in close coordination with their customers, leading to products that are specified into their customer's process and products. Competitors in the space need to be able to continuously improve their products to meet customer manufacturing requirements. Bakelite has served most of their top 10 customers for 20+ years. In addition, formaldehyde-based resins have a high water content and a short shelf-life (approximately 4 weeks). This creates a maximum economic shipping radius of 200 miles. The incumbent players have locational advantages with facilities located in close proximity to customer's locations.

Raw Material Pass-Through: While Bakelite's raw materials exhibit price volatility, the company's resin pricing contracts remove much of it. Eighty-five percent of Bakelite's volumes are covered by contracts or pricing mechanisms that allow for raw material price pass-through. Key raw materials (phenol, methanol and urea) are tied to market-based indices and the resin price moves monthly based on published market changes. In addition, annual adjustments are made for other costs such as overheads, freight, and other raw materials.

Established Position in Rationalized Market: Pro Forma the GP Chemicals acquisition, Bakelite maintains a number two market position (with 27% of volume) in North America and a number one market position (with 25% of volume) in Europe. The formaldehyde-based resins industry is rational and well-structured with the top three players accounting for 86% of volumes in North America and 53% of volumes in Europe.

Regulatory Tailwinds: Within the construction market there is growing emphasis on increasing use of cladding and insulating materials that exhibit favorable fire, smoke, and toxicity (FST) resistance. Phenolic resins can withstand high heat loads while maintaining mechanical strength and providing good FST resistance. Beyond the construction industry these features are highly sought after in the EV market where phenolic resins are used to supply battery boxes to EV automakers.

Phenol and Formaldehyde Exposure: Bakelite, as a formaldehyde-based resin producer, has exposure to formaldehyde, which has been classified by the EPA as a possible human carcinogen. Phenol is also a hazardous monomer. The industry, and Bakelite, have been responsive to concerns around phenol and formaldehyde emissions by changing formulations and using alternative bio-based materials. Phenol and formaldehyde emissions from products using Bakelite resins are below that of background emissions of these substances. They have developed formaldehyde-free resin options; however, at this point in time they are expensive and not widely used.

Derivation Summary

Bakelite is somewhat weakly positioned for its rating category. The company is smaller and maintains lower margins than peers such as Avient Corporation, Axalta Coating Systems Ltd., H.B. Fuller Company (BB/Stable), Ingevity Corporation (BB/Stable), and Kraton Corporation. Moreover, Bakelite's EBITDA leverage is higher than H.B. Fuller, Ingevity and Kraton, and roughly in-line with Axalta and Avient. Notably, Bakelite's FCF margin is in-line with Avient's and stronger than Kraton's, though materially lower than Axalta's and Ingevity's. Relative to 'B'-rated peer SK Mohawk Holdings, SARL, Bakelite is smaller, but maintains materially lower leverage and more resilient FCF margins.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer

A recession in 2023 affects both volumes (down 9%) and pricing (down 8%). Volumes and pricing both grow at 2%-3% per annum thereafter;

Raw materials costs fall from the weaker economic environment but also from negotiated contract savings and procurement improvements, leading to flat material margin/ton in 2023. Materials margin/ton improves thereafter as market recovery supports better pricing;

Full realization of synergies expected in 2024;

Capex of $30 million-$40 million/year, or 2.0%-2.4% of revenue;

Fitch assumes bolt-on acquisitions of $25 million in 2023 and 2024 (7.5x purchase multiple).

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Significant increase in size and scale while maintaining conservative credit metrics;

EBITDA margins approaching the mid-teens through raw material procurement improvements and/or improved pricing power;

EBITDA leverage durably below 3.0x.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

EBITDA margins trending toward mid-single digits on a sustained basis, indicating the inability to successfully pass on raw material costs or operating inefficiencies;

A deeper, more prolonged downturn that leads to EBITDA leverage durably above 4.0x;

Large debt-funded acquisitions or aggressive sponsor distribution policies.

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

Bakelite maintains adequate liquidity of $51 million at Sept. 30, 2022, consisting of $12 million in cash and $39 million in undrawn ABL availability. Fitch expects that Bakelite's total liquidity improved going into year-end with optional paydowns on its ABL.

Issuer Profile

Bakelite is a global integrated producer of phenolic specialty resins and engineered thermoset molding compounds used in building materials, automotive products, industrial applications and specialty chemical intermediates, with sales across multiple end markets in Europe and North America.

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

Bakelite US Holdco, Inc. has an ESG Relevance Score of '4' for Exposure to Social Impacts due to Bakelite's exposure to formaldehyde. The '4' score reflects concerns that consumers may take an adverse view regarding formaldehyde emissions notwithstanding the endemic nature of the material and the strong strides that Bakelite and the industry have taken in reducing emissions. It is important to note that formaldehyde emissions are endemic in the environment (humans and most living organisms emit it) and that Fitch does not consider the company's handling of formaldehyde as an issue. Bakelite, and the broader formaldehyde-based resins industry, has been responsive to concerns regarding formaldehyde. In fact, Bakelite has engineered their resins such that formaldehyde emissions from products containing their resins are below background levels and has formaldehyde-free product lines. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

(C) 2023 Electronic News Publishing, source ENP Newswire