Ovako : A successful restructuring story in the steel market

>Strengths / Opportunities - Leading local positions in the European engineering steel market: Ovako has a large market share in the Nordic countries and leading positions in industry niches (e.g. bearings) in other western European countries. Focus on specialty products: Ovako estimates, that ~80% of its products are custom designed. The high degree of customisation creates a degree of customer lock-in effect.Pricing mechanism: Ovako’s annual agreements include a pricing mechanism which allows it to pass through changes in raw material costs with a limited time lag.Cost reduction through restructuring initiatives: in 2015, Ovako launched a restructuring program targeting cost savings of € 50m from 2018. As of YE 2016 the company had already extracted restructuring savings of € 23m.Price recovery: steel prices have recovered slightly since mid-2016.Cash flow: FCF was at breakeven in 2016 despite restructuring costs of -€ 8m. Additional improvement in 2017 is very likely, due to i/ lower capex, ii/ lower restructuring costs, and iii/ further cost savings.Weaknesses / Threats - Relatively high fixed costs (~37% of total revenues in 2015): therefore, significant decreases in steel output have a noticeable negative impact on profitability.High adjusted net leverage of 5.8x at end-2016 (9.2x including the shareholder PIK/payment in kind loan). Net leverage did however improve from 6.8x at end-2015.Limited presence in Asia, with only 5% in total revenue in 2015. This is disadvantageous due to the shift of manufacturing resources from Europe to Asia in a bid to get closer to new customers and benefit from lower wages and labor costs. Customer dependency: according to Ovako, its largest customer represents ~15% of its revenues.Still-high uncertainty regarding the sustainability of the recent steel price recovery.Credit opinion: Stable Market recommendation: Buy - Our Stable credit opinion is based on i/ the company’s adequate liquidity situation even including the potential tax payment of € 9.5m, ii/ the obvious upward trend in earnings driven in particular by cost savings from the restructuring measures, iii/ visible positive FCF in 2017, and iv/ the improved outlook for steel prices. We note, however, that there is still a high level of uncertainty regarding the sustainability of the recent steel price recovery. The notes can be redeemed prematurely as of June 2016. While early repayment after June 2018 would generally be more advantageous due to the lower call price (100% from 1 June 2018), Ovako could try to refinance its notes earlier, starting in late 2017, in order to secure the low interest rates. Confirmation of the company’s upward earnings trend in the course of 2017 will be the key factor to obtain the follow-up financing, we believe. The bond has demonstrated a remarkable recovery since its low in March 2016 (Appendix 3) following the release of weak 2015 figures. The notes are currently trading at YTW of 5.9% (Appendix 4); this equals the YTC assuming a call on 1 June 2018. In relative terms, this yield is still attractive compared to the average yield of 3.9% of our broader bond peer group with similar ratings and workout dates (Appendix 5).