Winchester Parent’s Debt Ratings Affirmed Despite Near-Term Demand Headwinds

S&P Global Ratings affirmed the debt ratings of Olin Corp., parent of the Winchester ammo brand, although the rating agency expects Olin’s credit metrics will deteriorate from record levels realized during the past two years, primarily as a result of weaker demand for epoxy resins and vinyls products.

S&P said the company’s electrochemical unit (ECU) optimization and focus on value over volume will likely support higher trough pricing across its portfolio, although it expects pricing and volumes to decline versus 2022. Despite S&P’s expectation for earnings deterioration, it believes credit metrics and free cash flow generation will remain strong for the ‘BB+’ rating, with funds from operations (FFO) to debt of around 40 percent in 2023 and debt to EBITDA remaining below 2x.

S&P affirmed its ‘BB+’ issuer credit rating on Olin as well as its ‘BB+’ rating on the company’s unsecured notes, term loan, and revolving credit facility (RCF). The outlook remains positive, reflecting Olin’s improved balance sheet, management’s strategic initiatives that have enhanced earnings power and reduced earnings cyclicality, and our view that an upgrade is possible if management were to successfully navigate present recessionary conditions while maintaining credit metrics near our current projections.

S&P said in its analysis, “Current demand weakness across Olin’s end-markets may result in credit metrics below our upgrade trigger of 45 percent FFO to debt over the coming quarters.

“Since its inception in 2020, Olin’s strategic shift toward maximizing overall ECU profitability, rather than maximizing volume, has contributed to higher pricing and improved chlor-alkali profitability. Chlorine, caustic soda, and hydrogen are co-produced simultaneously by the electrolysis of salt, in a fixed ratio of 1 ton of chlorine to 1.1 tons of caustic soda and 0.03 tons of hydrogen (this is termed an ECU). Historically, this co-production process has resulted in relatively high earnings volatility for chlor-alkali producers since strong demand for one co-product can be an incentive to overproduce, causing subsequent pricing weakness in the other. To mitigate this volatility, Olin has focused on matching the company’s volume participation according to the weaker market (either chlorine or caustic), procuring existing molecules globally rather than producing the molecules internally (parlaying), and by toggling its participation in chlorine derivative chains and products to balance downstream supply and demand. Olin has also extended operating rate cuts and the idling of unprofitable capacity to its epoxy and small caliber ammunition (Winchester) businesses. The company’s ability to remove marginal molecules from the market during a period of exceptionally strong goods demand supported record earnings in 2021 and 2022, with adjusted EBITDA around $2.5 billion in both years (compared to a previous high watermark of around $1.25 billion in 2018). However, current demand weakness, particularly in products exposed to building, construction, urethanes, paints, and coatings, will be a key test of the company’s ability to execute its strategy and support earnings during a downturn.

“The company’s operating model is predicated on preemptively paring back volumes in the face of weak demand to support pricing and earnings over several years. Consequently, as demand has slowed, Olin has reduced operating rates in both chlor-alkali and epoxy, with its epoxy assets running below 50 percent in recent months. We anticipate these actions, along with more favorable merchant chlorine pricing, additional government small caliber ammunition contracts and a focus on higher margin epoxy systems will support trough earnings substantially higher than those realized in 2020. For example, while facing a substantial decline in demand (and significantly lower volume) in the fourth quarter of 2022, Olin was still able to generate about $450 million in S&P Global Ratings-adjusted EBITDA. However, the company faces certain short-term macroeconomic headwinds that are largely out of management’s control, including higher interest rates pressuring housing demand across the globe, weak (but improving) Chinese construction and infrastructure investment, and competition from foreign exports (particularly in epoxy). In our view, Olin’s potential to achieve an investment-grade rating hinges on the company’s ability to successfully navigate these challenges, support higher trough pricing and benefit from a rebound in both pricing and volume as demand returns. However, if a consistent decline in volumes failed to support pricing during the current period of demand weakness, or if the company was unable to significantly increase volumes, without affecting price, once demand strength returned, ultimately leading to market share erosion, we would expect credit metrics to remain below the level required for an investment-grade rating.

“We believe Olin’s financial policies and its demonstrated ability to generate strong, stable free cash flow throughout the cycle could support investment-grade credit metrics.

“Management recently stated publicly their desire to achieve and defend an investment-grade rating, and it expects net leverage to remain below 2x debt to adjusted EBITDA in a recessionary scenario (based on the mid-point of their 2023 adjusted EBITDA guidance). We believe Olin’s improved balance sheet and lower expected cash outlays make these targets achievable over the next 12 months. Olin has reduced gross balance sheet debt by about $1.3 billion (or 33 percent) since 2022, and we expect it will benefit from additional financial flexibility as a result of decreased cash interest expense, relatively stable maintenance capital expenditure (CAPEX) requirements, and no further contractual long-term supply payments. Ultimately, this should result in substantial free cash flow generation, even in a downturn. For example, in 2020, despite not operating under their current value-over-volume paradigm, and in a substantially weaker demand environment, Olin was able to generate about $200 million of free cash flow. Now with an improved operating model, and lower cash interest expense, we expect Olin will generate about $1 billion of free operating cash flow (FOCF) in 2023, even at substantially reduced operating rates. In our base case, we assume Olin will prioritize inorganic growth initiatives, including the pursuit of certain capital-lite growth vectors, such as additional parlaying activity and hydrogen projects. We do not expect the company will allocate capital to large-scale, capital-intensive investments to expand its existing asset base; however, we believe there is a risk Olin could undertake a large, transformative, and potentially debt-funded acquisition. Such a transaction could include the acquisition of incremental ECU capacity, an investment in existing or new downstream chlorine derivatives, or a partnership with a polyvinyl chloride (PVC) producer. However, given the company’s free cash flow generation, and stated commitment to maintain investment-grade credit metrics, a sizeable acquisition would not necessarily preclude an investment-grade rating. In the event of a large acquisition, we believe Olin has multiple levers (including the reduction of share repurchases) that could potentially allow it to fund a portion of any prospective deal using cash on hand and/or to rapidly delever post-acquisition. Additionally, an acquisition could be beneficial to our view of the company’s business risk, either by increasing the company’s scale, reducing its earnings cyclicality through the addition of noncorrelated derivative products, or by improving the efficiency and efficacy of its ECU-optimization strategy. In the absence of a large-scale acquisition, we anticipate Olin would continue to return the majority of discretionary cash flow (DCF) to shareholders via share repurchases, as it did in 2022, and we assume no further material debt repayment within the coming 12 months.

“The positive outlook reflects our view that Olin’s improved capital structure, financial policies, value maximization strategy, and strong free cash flow generation provide the company with increased financial and operational flexibility, such that it could sustain investment-grade credit metrics over a full economic cycle. Following its significant debt reduction in 2021 and 2022, we believe management is committed to maintaining debt to EBITDA below 2x (on a company-adjusted basis) in a recessionary environment, although there is a risk leverage could rise above this level in the event of a transformative or strategic acquisition. Offsetting the positive implications from an improved balance sheet and operating model are challenging macroeconomic factors, including weak end-market demand for epoxy resins and vinyls products due to a global slowdown in building and construction activity, and the actions of its competitors, which have not been as keen to reduce operating rates and match output with market demand. We believe the risk of a further economic slowdown within the coming few quarters could pressure the company’s earnings in the near term, and force Olin to cut operating rates further to support market pricing, ultimately leading to lower volumes, market share erosion, and financial metrics below the level required for an upgrade to investment grade.”