Perstorp Holding AB : Strong earnings momentum in 2017 so far, but high cash interest burden... Buy recommendation on fixed rate notes; Reduce on floater

>Strengths / Opportunities - Leading positions in niche, though global, speciality chemicals markets; 80% of net sales earned in oligopolistic markets where Perstorp holds a top-3 position.High industry growth expectation and relatively high barriers to entry.Historically quite stable product prices; ability to widely pass-through feedstock costs with relative short time lag; highly flexible cost structure (c.80% is variable).No material customer concentration (c.3,000 customers in 100 countries; top 5 customers accounted for a low 14% of net sales in 2016); diversification of end-user markets but some dependence on market segment sales for coatings (c.34% of net sales).Low maintenance capex requirements (c.2-3% of revenue p.a.), although growth strategy triggered high expansion capex in recent years and SEK 600+m p.a. should be expected going forward (about 50% maintenance; 50% growth).At least average recovery expectations (S&P: 64%; MDY: 76%) on first-lien notes.Weaknesses / Threats - Raw material sourcing from a limited number of suppliers; dependency on Borealis as feedstock supplier (accounting for c.25% of total raw material sourcing) within the Oxo product tree; a history of supply bottlenecks with adverse EBITDA impact.Extremely leveraged (Oddo adj.: 7.2x at end-June 2017) and multi-layered capital structure in a cyclical industry; very low interest coverage (Oddo adj.: 1.3x at end-June 2017) and interest rate risk; de-leveraging possible from asset sales or IPO.RCF and hedging liabilities have priority over first-lien notes; second-lien notes have likely limited to no recovery potential at all.Price swings in crude oil and natural gas negatively affecting feedstock input costs; no raw material hedging policy in place; partial reliance on manual price adjustments.Strong production backbone in Sweden and global sales lead to material FX risk, mitigated to a small extent by partial FX hedging and $ and € debt outstanding.Larger peers have more financial resources and deeper R&D capabilities, although in niche segments Perstorp has no disadvantages.Above-average regulatory standards that could entail adverse cost effects.Call and redemption risk from asset sales at unfavourable terms for bond holders.Credit Opinion: ‘CCC+’/Positive; Recommendation: PERHOL 7.625 06/30/2021 SSN: Buy; PERHOL FLOAT 06/30/2021: Reduce - Credit Opinion: Perstorp is a speciality chemicals niche markets champion with a lot of credit positive features: sound profitability, low maintenance capex needs, and a highly flexible cost structure, partially offset by high leverage, low interest coverage, further growth capex and supplier dependencies. If management sticks to its goal of normalised capex spending (c.SEK 600+m p.a.) and further growth, this would allow some free cash flow generation and thus de-leveraging. We assign a ‘CCC+’ with a Positive outlook. Recommendation: Our relative value analysis is constrained by the need to compare operationally sound but highly leveraged Perstorp with issuers facing distorted earnings and/or high leverage. Perstorp’s industry and market position as well as its potential ownership support – as shown by PAI Partners in 2009 – are other factors that lead us to believe that a pure rating/yield does not tell the whole story. We issue the following recommendations (see “view and recommendation” for details): 1/ € 285m 7.625% SSN due June 2021: Buy; 2/ € 200m floating (3M EURIBOR plus 7.625%) SSN due June 2021: Reduce.; 3/ We do not issue recommendations for the $ tranches.