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Frankfurt am Main, July 25, 2022 -- Moody's Investors Service, ("Moody's") has today downgraded Mangrove LuxCo III S.a r.l.'s (Mangrove) corporate family rating (CFR) to Caa2 from Caa1 and its probability of default rating (PDR) to Caa2-PD from Caa1-PD. Concurrently, the rating agency downgraded to Caa2 from Caa1 the rating on the company's €356 million guaranteed senior secured notes due 2025. The outlook was changed to stable from negative.
The ratings downgrade reflects Mangrove's considerably strained liquidity, high financial leverage, weak credit metrics and poor track record of free cash flow (FCF) generation. The downgrade also incorporates Moody's concerns about sustainability of the company's operating cash flow generation amid materially slower global economic growth, lower consumer and business sentiment, persistently high inflation, and renewed supply chain disruptions. This could result in a liquidity shortfall and an increased probability of default.
At the beginning of Q2 2022, Mangrove faced a significant working capital consumption, which was driven by inventory buildup amid supply chain challenges and high materials prices and some delay in customer payments. To support its liquidity the company drew the remaining €55 million under its €65 million committed long-term revolving credit facility (RCF), which left Mangrove with no external sources to absorb any potential liquidity crunch. After some working capital improvements during May and June, as of 30 June 2022, Moody's estimates that the company had around €80 million of cash on balance (including around €20 million outside of cash pooling and not immediately available to the parent). Despite a very high order backlog and continuously strong order intake in H1 2022, Mangrove's EBITDA came under pressure because of cost inflation, which the company was only able to mitigate with a delayed cost passthrough to customers. As a result, the headroom under the company's maintenance financial covenants has considerably tightened.
Moody's expects Mangrove's FCF to remain persistently negative at least through 2023. The agency expects the company's margins to remain under pressure, only partly mitigated by cost passthrough and restructuring initiatives. The high 2021 order intake does not fully capture incurred cost inflation and it will take time to trade it out, hence offsetting gains from the new orders. To avoid liquidity stress, Mangrove will have to maintain focus on tight working capital management and balanced growth capital spending. The risks are skewed to the downside given the softening macroeconomic environment. Potential gas curtailment in Europe represents additional downside risks to the company's performance. This would mostly have an indirect impact on Mangrove from weakening demand and intensified supply chain issues. The company's own production process is not energy intensive (in relative terms).
The Caa2 CFR is constrained by Mangrove's weak liquidity; high leverage of around 8.5x as of end-March 2022 and expected to remain elevated (in the high single-digits) through at least 2023; the cyclical nature of its end markets; and the event risk because of the ongoing legal dispute following the restructuring of Galapagos Holding S.A.
The rating also takes into account Mangrove's established position in the global heat exchanger market, with a broad product portfolio, global production capability and geographical diversification; the criticality of the heat exchanger product, which typically accounts for a small percentage of the overall cost of a large power plant or asset; the company's recent expansion into the data center application market, which has solid growth fundamentals; and potential support from the shareholder in case of need.
In the agency's view, Mangrove's liquidity has weakened, considering no available external sources to address liquidity needs in an increasingly softening economic environment. As of 30 June 2022, Moody's estimates that the company had around €80 million of cash on balance (including around €20 million outside of cash pooling and not immediately available to the parent). Over the next 12 months, Moody's expects Mangrove to generate around €30 million in funds from operations (after interest payments), which, together with available cash on balance, will be just enough to cover the expected liquidity needs, including working cash, working capital needs, capital expenditure (including lease payments). The liquidity sources are very tight to absorb additional growth capital spending and extraordinary working capital swings stemming from continuing supply chain challenges or delay in customer payments.
Through the end of 2023 Mangrove does not have any material debt maturities. The €65 million fully drawn RCF is due October 2023 but has a one-year auto extension option if the audit report for 2022 financial result does not raise any questions regarding the company's going concern status. The company's guaranteed senior secured bonds mature in October 2025.
The RCF requires compliance with several maintenance financial covenants, including minimum EBITDA, net leverage and minimum cash, which are tested quarterly. Mangrove is likely to breach the first two covenants in H2 2022 and is currently negotiating a covenant reset with its lenders. If the new covenant test levels are agreed by the lenders, as proposed by the company, Moody's expects Mangrove to comply with its covenants through the end 2023, but the headroom will be modest.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
Governance considerations are material to the rating action. The company's financial policy remains aggressive reflected in very high financial leverage and weak liquidity.
In the assessment of the priority of claims in a default scenario for Mangrove, we distinguish among three layers of debt in the capital structure: the senior secured €65 million RCF ranks on top of the capital structure, followed by the €356 million guaranteed senior secured notes and trade payables, and behind these debt instruments are pension liability and current lease obligations. The Caa2 rating of the guaranteed senior secured notes is in line with the CFR.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects Moody's expectation that over the next 12-18 months Mangrove's sizeable order backlog will support its earnings generation helping to mitigate further pressure on liquidity. The stable outlook assumes Mangrove will successfully renegotiate its covenant reset before the Q3 2022 covenant test. The absence of debt maturity until October 2024 further mitigates liquidity risk and also supports the stable outlook.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Further downward pressure on the ratings could materialise should operating performance deteriorate or liquidity continue to weaken or should Moody's assessment of the likelihood of a default increase. The ratings could also be downgraded if there is an adverse court ruling regarding the claims by the senior unsecured bondholders of Galapagos, leading to higher debt for Mangrove.
The ratings could be upgraded if there is a meaningful improvement in operating performance with Mangrove turning its large order backlog into profitable revenue and the company's liquidity strengthens.
The principal methodology used in these ratings was Manufacturing published in September 2021 and available at https://ratings.moodys.com/api/rmc-documents/74970 . Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
Luxembourg-based Mangrove LuxCo III S.a r.l. (Mangrove) is the parent of companies that operate under the name Kelvion. The company is a leading global manufacturer of heat exchangers for a variety of industrial applications. These primarily include the HVAC and refrigeration, power generation, and oil and gas sectors but also the data center, food and beverages, chemicals and marine businesses. The company is owned by a fund managed by Triton Partners, a private equity group. In the 12 months that ended 31 March 2022, Mangrove generated around €916 million in revenue and around €70 million in company-adjusted EBITDA (including IFRS16 effect).
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions .
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Elvira Nurgalieva Analyst Corporate Finance Group Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main, 60322 Germany JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
Karen Berckmann, CFA Associate Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
Releasing Office: Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main, 60322 Germany JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
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