K+S AG : K+S is navigating into calmer waters, but the bonds are unattractive now – even in an upgrade scenario

After a difficult 2017, we believe that the worst is behind K+S. It has settled its environmental-related disputes and production stoppages at its German facilities will probably not be seen in the future, while it commissioned its large-scale plant in Bethune, Canada. We take great comfort from the fact that operational and legal uncertainties with regard to saline wastewater management have now been removed. - In 2017, group revenue rose by 4.9% YoY to € 3.63bn (2016: € 3.46bn), driven by higher volumes, but our adjusted EBITDA declined to € 609.3m (€ 691.9m) and cash flow available for debt service was still negative at –€ 392.4m (2016: –€ 931.5m). - Persistently low potash industry utilisation, which is forecast to decline going forward, and trade war concerns, which have begun to hinder the agricultural market, are risks to the credit story. However, it seems that the former will not affect potash players as producers have remained disciplined, while the latter's development is not yet visible. If this affects trade routes, K+S's geographic diversification should help the company. - >Credit opinion - We maintain our Stable credit opinion.K+S has reached a turning point in our view and leverage should fall slightly during 2018, driven by higher EBITDA from increased potash and salt volumes and higher potash prices. 2018 will be another year of transition, but K+S should be able to generate cash after many years of cash burn in 2019.We continue to see an upgrade to 'BB+' as a more realistic scenario for 2020 and further out.We believe that Moody's will rather restore the stable outlook than downgrade K+S as continued growth and profit improvements further out would otherwise require a quick counter action by Moody's.Recommendation - We are changing our recommendation to Reduce on all issues except for the-soon-to-mature 2018 paper (Neutral).All K+S issues, except the-soon-to-mature 2018 paper, offer low returns for a 'BB' risk. 'BB+' bonds are also comparable to K+S issues as we expect a medium-term upgrade, but even then the K+S notes would hardly justify a Neutral recommendation. However, for the sake of completeness, K+S is in our view a fairly safe bet and investors seeking credit-risk-driven returns stand to benefit from maintaining positions or investing in the credit.K+S will issue a new bond in 2018 to refinance the 2018 maturity.