Ovako : We change our recommendation to Reduce on tight valuation

Ovako performed strong in 2017 with volumes and prices driving topline and EBITDA. Revenue rose by 18% yoy to € 921.3m and EBITDA before restructuring grew by 75% yoy to € 99.6m. Nevertheless, free cash flow was depressed due to WC ramp up (negative swing of –€ 38m). - Sales volume, price and mix effects had a positive impact on earnings of € 36m in 2017, after taking into account costs for capacity increases. The restructuring program contributed € 20m in reduced fixed and variable costs, before cost inflation of € 9m. Timing effects of scrap and alloy prices affected earnings by a low –€ 2m. FX had no material effect on earnings. - Management highlighted several times during the year that costs for graphite electrodes rose significantly. This is driven by 1/ GE supplier concentration and capacity cuts, 2/ increasing usage of needle coke (which accounts for half of GE production costs) in LI batteries and 3/ rising steel demand. Nevertheless, while sale volume rose by 11% yoy to 783 ktonne, average prices rose by 7% yoy to €1,175 per tonne, EBITDA before restructuring per tonne rose by 159% yoy to € 127. - Ovako’s bond documentation contains a Special Redemption clause and allows the company to redeem up to 40% of the nominal through an equity offering. If the clause will be triggered depends on the timing of the IPO and if equity investors deem the company’s leverage as acceptable or not. In the latter case Ovako would need to use IPO proceeds to bring credit stats in order. Naturally, Ovako’s owner Triton wants to avoid this. Recent equity market turmoil could make a listing difficult, particularly for a cyclical business with more or less peaking results. - We have been asked by investors if they would receive accrued interest in a special redemption scenario. Indeed, the documentation does not reveal this instantly (see view and recommendation section). - - >Credit Opinion: - If the recent equity market shake up will prevent Triton from IPOing Ovako is difficult to say right now. Operating performance is strong and will remain so in the short-term, we believe. Although we believe that its profitability is peaking. Tail risk or sharp economic contraction can never be ruled out, which would be severe to Ovako given its cyclicality. Our Stable credit opinion assumes already an upgrade to ‘B’ and ‘B2’.Recommendation: - The bond is expensive now and therefore we change our recommendation to Reduce. Note that a potential IPO of the company could be subject to a special redemption clause. Hereby the instrument could be called by up to 40% at 102%.