Vallourec : Earnings growth set to remain modest in 2017

Vallourec reported stronger-than-forecast 2016 results, with strong growth in volumes driven by the business recovery in North America. However, the group is expected to continue to generate negative EBITDA and FCF in 2017 owing to modest recovery in other regions and substantial price pressure. Against this backdrop, we reiterate our Negative credit opinion and Reduce recommendation, as the bonds continue to underperform their counterparts. - - >Vallourec reported improved Q4 2016 results - Although volumes expanded by 17.5% in Q4 2016 on the back of the business recovery in the US, sales fell by -2.7% to € 838m attributable to a negative price-mix effect of -24.9%. The smooth-running of the strategic plans led to an increase in EBITDA to 1e€ 63m compared with -€ 77m in Q4 2015. FCF burn totalled 1e€ 3m compared with FCF generation of € 100m in Q4 2015. Following the capital increase of about € 1bn in 2016, net debt came to € 1.29bn at end-December vs. € 1.52bn at end-2015, representing a net debt-to-equity ratio of 34% for a covenant of 75%. The group still boasts a strong liquidity position of € 3.6bn.Despite the business recovery in the US, 2017 results are likely to remain under pressure - The pickup in the US at the end of 2016 is expected to firm up in 2017 and should lead to significant volume growth in the region. Against a backdrop of still limited investments in the oil & gas sector, the other regions have yet to show a rebound. The price-mix effect is expected to remain negative given the delivery of orders placed on unfavourable pricing terms in 2016 and the US' bigger share of the product mix. Despite the smooth implementation of measures to reduce costs and improve competitiveness, EBITDA is expected to remain negative in 2017 (1e € 125m expected, and -€ 170m to -€ 120m forecast by the group). FCF is also projected to remain in negative territory (-€ 340m). Cash consumption is expected to result in higher net debt (€ 1.7bn estimated in 2017) and dent the group's liquidity. In this context, S&P decided to downgrade Vallourec's rating to 'B' from 'B+' and maintain its negative outlook.We reiterate our Negative credit opinion and our Reduce recommendation on the Vallourec bonds - The performance of VKFP 19 and 24 bonds was impacted by the disappointing outlook for 2017 and may be hampered in the coming quarters by marginal earnings improvement. Although there are no comparable bonds in the same sector as Vallourec, the 2019 paper offer a yield below the sector average (1.9% vs. 3.2%) whereas the 2024 bond yield is in line with similar bonds (5.3% vs. 5.2% on average).