Fitch Ratings has assigned a 'BB+' rating to the proposed senior unsecured sustainability-linked notes due 2031 to be issued by Klabin Austria Gmbh and guaranteed by Klabin S.A. (Klabin).
Proceeds from the senior notes will be used for the tender offer for any and all of its outstanding 2024 notes and for general corporate purposes. Fitch currently rates Klabin S.A.'s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) 'BB+'/Outlook Stable.
The sustainability-linked securities framework establishes a water consumption intensity target equal to or less than 3.68 m3/t on Dec. 31, 2025; a waste reuse and recycling target as a percentage equal to or greater than 97.5% on Dec. 31, 2025; and reintroduction and/or reinforcement of wild species into the ecosystem of at least two extinct or threatened species, calculated through rewilding initiatives concluded by 2025, with an interest rate step up if Klabin fails to meet the targets.
Klabin's ratings reflect the company's leading position in the Brazilian packaging sector, large forestry based, providing a low production cost structure, access to inexpensive fiber and a high degree of vertical integration, which enhances product flexibility in the competitive but fragmented packaging industry. Because of its strong market business position in packaging products and integrated operations, Klabin is a price leader in the domestic market and is able to preserve more stable sales volume and operating margins during more instable economic scenarios in Brazil than its competitors, which have significantly lower scale of operations and high exposure in production costs. The company also benefits from its position as a low-cost producer of market pulp, in the lowest quartile, and maintains pulp production volumes above 90% of nominal capacity.
Klabin's solid liquidity position and low refinancing risk remain key credit considerations. The analysis considers the investments in the Puma II project, which will further strengthen the company's leading market position in the packaging business. The ratings incorporate a recovery of EBITDA to BRL4.7 billion in 2020, as per Fitch's calculations, and an increase in net debt excluding factoring transactions to BRL20.7 billion, from BRL3.7 billion and BRL14.4 billion, respectively, in 2019. Fitch's base case projections incorporate net leverage to increase to about 4.5x in 2020, declining to about 3.5x by 2022. This amount of net debt and the leverage ratios remain within Fitch's expectation in the midst of the project.
The Stable Rating Outlook reflects Fitch's expectation of strong operating cash flow, despite the severe economic downturn and weak pulp prices, benefiting from the depreciation of Brazilian real and strong demand for coated board and corrugated boxes, as demand remained supported by the company's leading position, diversified client base in the more resilient food sector and the fast-growing ecommerce in Brazil.
KEY RATING DRIVERS
Leading Position in the Brazilian Packaging Segment: Klabin is the leader in the Brazilian corrugated boxes and coated board sectors with market shares of 24% and 50%, respectively. In the Brazilian market, the company is the sole producer of liquid packaging board and is the largest producer of kraftliner and industrial bags, with market shares of 42% and 56%, respectively.
In Fitch's opinion, the expansion project is very strategic for Klabin and will add 920,000 tons of annual production capacity of kraftliner by 2023, positioning the company as the world's third-largest kraftliner paper producer. Klabin's strong market shares allow it to be a price leader in Brazil. The company's competitive advantage is viewed as sustainable due to its scale, high level of integration and diversified client base in the more resilient food sector. This allows Klabin to preserve EBITDA margins above 30% throughout the cycle, while small players have margins below 15%.
Pulp Mill and Forestry Assets Positive Rating Considerations: Klabin has a 1.6 million-ton pulp mill that started operations in 2016. Klabin sources much of its fiber requirements from hardwood and softwood trees grown on 264,000 hectares of plantations it has developed on 594,000 hectares of lands under management; this ensures a competitive production cost structure in the future.
During third-quarter 2020, the company's cash cost of production was USD141 per ton, which placed it firmly in the lowest quartile of the cost curve. The accounting value of Klabin's land was about BRL2.3 billion as of Sept. 30, 2020, and the value of the biological assets on its forest plantations was BRL4.4 billion. If needed, some of the forestry assets could be monetized to lower debt and improve liquidity.
FCF to Remain Negative: Consolidated adjusted EBITDA is expected to be around BRL4.7 billion for 2020 and BRL5.5 billion in 2021 and cash flow from operations of BRL4.6 billion and BRL3.5 billion, respectively. Klabin generated BRL3.7 billion of adjusted EBITDA and BRL3.2 billion of cash flow from operations in 2019, as per Fitch's calculations.
Klabin's flexibility and product diversification will continue to soften the impact of the severe economic downturn in Brazil and weak pulp prices. Fitch's projections considered a 9% increase in paper and packaging sales volume, to 2.0 million tons in 2020, further increasing in 2021 following the start-up of the first phase of Puma II project and between 1.5 million tons and 1.6 million tons of pulp for 2020 and 2021. Fitch expects negative FCF of about BRL365 million in 2020 and BRL820 million in 2021, due to investments in the Puma II project.
Positive FCF is expected only for 2023, when investments start to reduce. Fitch's base case incorporates total investments around BRL8.2 billion during 2020 and 2021 and annual dividends between BRL300 million and BRL500 million during the period.
Leverage to Slowly Reduce: Fitch expects net adjusted leverage, excluding factoring transactions, to increase to about 4.5x in 2020 due to investments in the expansion project and to decline to around 3.5x by 2022 as EBITDA generation improves. Net debt is expected to peak at BRL22 billion in 2022; this compares with BRL14.4 billion at the end of 2019.
Fitch expects Klabin to continue to manage its capital structure conservatively during the expansion phase and take proactive steps if leverage exceeds 5.0x. In the LTM ended Sept. 2020, net debt excluding factoring/EBITDA was 4.8x, according to Fitch's methodology, pressured by weaker pulp prices and high investments.
Pulp Prices to Slightly Improve: The market pulp industry is cyclical; prices move sharply in response to changes in demand or supply. Fitch expects a slight recovery of pulp prices during 2021, as producers reduced excess inventory during 2020 and prices have likely bottomed out. Weaker demand stifled a recovery in the sector in 2020, following a pulp price collapse in 2019 - pulp prices plummeted to USD480/ton in December 2019 from USD715/ton in January 2019. Pulp prices remained below USD500/ton throughout 2020. A sustainable pulp price recovery should continue to rely on supply reduction, and a recovery of European and U.S. paper and packaging demand will depend on world economic growth during 2021 and the pace at which employees return to offices.
Rating Pierces Country Ceiling: Klabin's 'BB+' Long-Term Foreign Currency IDR is one notch higher than Brazil's 'BB' Country Ceiling due to a combination of exports of about USD1 billion, about USD187 million of cash held outside of Brazil, and USD500 million unused revolving credit facility.
Fitch projects the ratio of exports, plus cash held abroad to cover hard currency debt service over the next 24 months above 1.5x, in line with Fitch's 'Non-Financial Corporates Exceeding the Country Ceiling Rating Criteria.' This could lead to a three-notch upgrade above the Brazilian Country Ceiling. However, Klabin's Foreign Currency IDR is constrained by the company's 'BB+' Local Currency IDR, which is a reflection of the company's underlying credit quality.
DERIVATION SUMMARY
Klabin has a leading position in the Brazilian packaging segment. Klabin's size, access to inexpensive fiber and high level of integration relative to many of its competitors give it competitive advantages that Fitch view as sustainable. Its business profile is consistent with a rating in the 'BBB' category.
Klabin's leverage is high compared with Latin America peers Empresas CMPC (BBB/Stable) and Celulosa Arauco (BBB/Negative). Klabin's leverage increased as a result of the construction of the Puma pulp mill and low pulp prices following the completion of the mill have prevented a quick deleveraging process. Klabin's net adjusted leverage should increase to around 4.5x due to the investments in Puma II project and is expected to decline to about 3.5x by 2022. Liquidity is historically strong for pulp and packaging producers, and Klabin has strong access to debt and capital markets.
Klabin is more exposed to demand from the local market than Suzano (BBB-/Negative), CMPC and Arauco, as these companies are leading producers of market pulp sold globally. This makes Klabin more vulnerable to macroeconomic conditions than its peers, which is also a negative consideration. Positively, its concentration of sales to the food industry, which is relatively resilient to downturns in Brazil's economy, and its position as the sole producer of liquid packaging board, adds stability to operating results.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within the Rating Case for the Issuer
Paper and packaging sales volume of 2.0 million tons for 2020 and 2.3 million tons for 2021;
Pulp sales volume between 1.5 million tons and 1.6 million tons in 2020 and 2021;
Average hardwood net pulp price of USD450 per ton in 2020 and USD525 per ton in 2021;
Average FX rate of 5.3 BRL/USD in 2020 and 2021;
Investments around BRL8.2 billion during 2020 and 2021, of which about BRL6.0 billion will be invested in the Puma II project;
Annual dividends between BRL300 million and BRL500 million in 2020 and 2021.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Average net debt/EBITDA ratios of 3.0x or below throughout the pulp price cycle following completion of the expansion project could lead to positive rating actions;
Sustained net debt at Klabin of less than USD3.5 billion after completion of the expansion project would likely lead to a positive rating action.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Net leverage ratios higher than 4.5x during the expansion project could lead to a negative rating action;
Average net debt/EBITDA ratios of 4.0x or higher throughout the pulp price cycle following completion of the expansion would lead to a negative rating action;
Sustained net debt at Klabin of more than USD4.5 billion after completion of the expansion project would likely lead to a negative rating action;
More unstable macroeconomic environment that weakens demand for the company's packaging products as well as prices.
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
Solid Liquidity: Klabin's solid liquidity position and low refinancing risk remain key credit considerations. As of Sept. 30, 2020, the company had BRL7.8 billion of cash and marketable securities and BRL31.1 billion of total debt, including about BRL2.2 billion of factoring transactions as per Fitch's criteria.
The company has an extended debt amortization profile, with BRL817 million of debt maturing by year end 2021 and BRL1.3 billion in 2022, excluding factoring transactions. Financial flexibility is enhanced by a USD500 million unused revolving credit facility. Klabin plans to continue to finance the expansion project with a combination of debt and operating cash flow. Fitch expects Klabin to continue to preserve strong liquidity, conservatively positioning it for the price and demand volatility, which is an inherent risk of the packaging industry.
As of Sept. 30, 2020, about 69% of total debt was denominated in U.S. dollars. Total debt of BRL31.1 billion consisted of bonds (41%), export credit notes (12%), Agribusiness Receivables Certificate (CRA, 12%), swaps (7%), factoring (7%), Finnvera & Bid Invest (7%), debentures (6%) and others (8%).
ESG CONSIDERATIONS
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.
KLABIN S.A. 
