On May 28, 2003, Standard & Poor's Ratings Services affirmed its ratings on PPG Industries (PPG) and removed them from CreditWatch where they were placed on Apr. 16, 2003, with negative implications.
The affirmation reflected the expectation that the company's meaningful exposure to unfunded postretirement benefit liabilities, including defined benefit pension and retirement medical liabilities, will not hamper its ability to further reduce total adjusted debt in order to strengthen substandard cash flow protection measures to levels consistent with the current ratings. Despite an expected slow overall economic expansion, PPG should continue to generate substantial discretionary cash flows for use in the lowering of its on-balance sheet debt, which will begin to offset the recent increase in unfunded postretirement benefit obligations, and result in an improvement to the company's overall debt leverage.
Credit quality incorporates PPG's strong competitive positions in major coatings, flat glass, and fabricated glass markets; ample discretionary cash flows; an agreement for settlement of asbestos litigation; and management's long track record of conservative financial policies, which should lead to further strengthening of the capital structure. PPG participates in industry sectors that are mostly mature. However, respectable operating margins over the course of a business cycle, proven dedication to cost efficiency, and ongoing commercialization of new products based on technology innovations are key supports for the above-average business profile.
Coatings and glass operations (accounting for about 69% and 16%, respectively, of operating profits) depend on a variety of end markets, including vehicles, consumer goods, industrial goods, and construction. Hence, the fundamental cyclicality of these markets is a risk factor. However, significant service and aftermarket businesses provide a solid base of earnings during economic downturns, and the results benefit from continual operating efficiency enhancements. Commodity chlor-alkali products, which represent the majority of chemical operations revenues, are prone to sharp cyclical swings, but a low manufacturing cost profile aids profitability at industry troughs and produces cash through the cycle.
Overall profitability faces another year of difficult conditions in most global markets, including the prospect of a moderate decline in U.S. light vehicle sales in 2003. Still, actions related to the restructuring charge taken in 2002 are expected to further improve earnings from the coatings unit, which accounts for most of the company's profitability. Operating margins (before depreciation and amortization) are in the area of 17%, compared with 20% to 23% in previous years.
An asbestos settlement agreement has been reached covering current and future asbestos-related product liability claims against PPG and 50%-owned Pittsburgh Corning Corp. (which filed for bankruptcy in 2000). The settlement would become effective after Pittsburgh Corning's bankruptcy plan of reorganization, incorporating the settlement, is approved by a court order and is no longer subject to appeal. Roughly $400 million of aftertax contributions (excluding the value of stock as part of the payment) over a 21-year period by PPG to an asbestos trust is included in Standard & Poor's debt leverage measures. Including the asbestos liabilities and adjustments for PPG's sizable underfunded post-retiree benefit obligations, debt to capital is aggressive.
A major credit strength is the company's ability to generate ample discretionary cash flows. Capital expenditures this year are expected to remain modest, in the $250 million to $300 million range, and any acquisition activity in the near term is expected to be insignificant. Consequently, discretionary cash flows for 2003 should be at least $350 million and be used for further reduction of the debt load or building of the cash position to meet debt maturities in 2004. EBIT interest coverage (excluding the asbestos charge) should strengthen from the reasonable 6x area.
Based on PPG's strong commitment to the reduction of on-balance sheet debt, Standard & Poor's expects that the key ratio of funds from operations to total adjusted debt, including debt-like postretiree benefit obligations, to improve toward the appropriate 50% area over the next several years, from subpar levels at the end of 2002. Moreover, there are no mandatory pension funding requirements currently for PPG. The company is considering a small $20 million to $30 million voluntary contribution this year as it would delay the need to make another contribution until at least 2006 even if equity markets remain flat. PPG's discount rate assumptions and expected long term return on assets are reasonable, and projected long term benefit payments for the U.S. pension plan appear very manageable. The cash payment for other postretirement benefits should also remain manageable, aided by participants in these plans sharing a major portion of annual cost increases.
Liquidity: Liquidity is likely to remain satisfactory, reflecting the company's healthy cash generation and commitment to lowering the debt-to-capital ratio. As of Mar. 31, 2003, credit facilities consist of $600 million maturing in 2006 and a $555 million 364-day line expiring in June 2003. PPG is in the process of refinancing the 364-day facility. The lines support commercial paper programs in the U.S., Europe, and Canada. As of Mar. 31, 2003, commercial paper borrowings totaled $250 million, and other short-term borrowings were about $80 million, while the cash position was $77 million. Debt maturities during the next several years are manageable, given PPG's ability to generate cash and access to capital markets, at $32 million in 2003, $339 million in 2004, and $116 million in 2005.
Outlook: Key cash flow protection and debt leverage measures remain meaningfully below appropriate levels, even when excluding unfunded benefits obligations. As a result, the company has virtually no flexibility for acquisitions or share repurchases. A critical consideration for the ratings is the expectation that management's conservative financial policies will remain intact (especially in the absence of a sustained business improvement). However, the company will need to achieve significant and consistent debt reduction during 2003 and 2004 in order to avoid a downgrade. From Standard & Poor's RatingsDirect