: Initiation of coverage at ‘BB’/Stable; Neutral recommendation on 2018, 2021 and 2022 straight bonds

>Strengths / Opportunities - K+S has leading positions in the global salt (No. 1) and potash (No. 5) markets.Well diversified geographically and in terms of end-industries and applications.Population growth (c. 0.8% p.a. until 2050) and the world’s need to maximise agricultural yields are key long-term business drivers.Commissioning of Legacy mine to positively affect K+S’s trade routes and operating costs.High entry barriers due to high capex needs and geographical concentration of deposits.Substantial liquidity resources (to far extent undrawn € 1bn RCF until 2020).Potential acquisition target for an investment grade rated company (currently unlikely).Weaknesses / Threats - Near-term outlook challenged by weak trading environment for potash.Depressed potash prices due to overcapacity and industry-wide expansion projects.Potash and Magnesium business is highly cyclical; de-icing volumes in the Salt business unit are weather-dependent.Global warming may structurally reduce the demand for de-icing salt (40.1% of Salt business unit revenue in 2015).Saline waste water issue at Werra site still unresolved, leading to production stoppage.Rising net leverage (Oddo adj.: 5x at End-Q3 16 from 2.4x at YE 15 – including sizeable long-dated mining provisions) driven by Legacy capex and weak EBITDA contribution.Economic FX risk due to large German production base and material overseas sales.Active dividend policy reduces financial flexibility.Long-term substitution risk from genetic plant modification and/or vertical farming.Credit Opinion: Stable / Market recommendation: Neutral (all bonds) - Credit Opinion: K+S’s credit profile is characterised by rising net leverage as a result of high Legacy-related capex and weak EBITDA. With the Legacy mine finally coming online in Q2 17 and capex levels normalising after 2017, the cash drain will come to an end even if potash prices and de-icing demand remain on depressed 2016 levels. Only more severe volume and price pressure in Potash and Magnesium, accompanied by low de-icing volumes, could challenge K+S’s viability in our view. This cannot be ruled out, but appears too pessimistic. The world’s basic need for agricultural products, population growth and the effectiveness and low substitution risk of potash as a fertilizer actually provide a firm foundation for long-term growth, although current bond investors with maturities in latest 2022 issue won’t fully benefit from this. The company’s recent successful € 700m promissory notes issue in 3-7y tranches at an average of 1% underlines K+S’s benign funding situation, although this issue occurred before S&P’s downgrade. With no meaningful potash price recovery, de-leveraging won’t be possible and the current outstanding instruments need to be refinanced rather than repaid. Our Credit Opinion is ‘BB’ / Stable as we expect potash prices to remain under pressure, but rather on 2016 levels.Recommendation: We find the bond pricing generous with all instruments trading far above par. The low (relative) return of the outstanding bonds and the risk of a further downgrade (which we anticipate with our rating already) make them no buy candidates. In terms of the ECB’s CSPP we note that the Eurosystem is not required to sell non-investment grade rated bonds. For now we issue a neutral recommendation. For a buy recommendation, the bond return should be materially higher to capture all existing issues and the weak industry outlook. A sell recommendation would need e.g. an even more meaningful deterioration of K+S’s performance as a catalyst for further downgrades.