Packaging Europe: susceptible, but not immune, to coronavirus disruptions

Despite the sector's low coronavirus exposure, some companies are more vulnerable

We have identified the non-paper packaging sector in EMEA as having overall low exposure to the coronavirus pandemic compared with some other sectors, such as automotive or airlines. Most of the aggregate revenue of the 15 non-paper packaging manufacturers we rate is generated from relatively resilient end markets, such as food, beverage (alcoholic and nonalcoholic) and pharmaceuticals , and is also fairly well diversified by geography, although with some natural concentration in Europe .

However, some of the European packaging companies we rate are more vulnerable than others to the negative effects of the pandemic. We think that the social distancing measures and lockdowns across several countries will curb the demand for more discretionary products, such as cosmetics and beauty products. They will also weigh on products that tend to be consumed in higher quantities in social gatherings, such as certain alcoholic beverages, or are sold via the hospitality (hotels, restaurants and caterers) and travel channels, partially mitigated by an expected increase in household consumption and online demand. The global recession that we are forecasting for 2020 will also hurt consumer spending for these categories of products.

Meanwhile, some packaging companies serving food and pharma end markets are likely to fare better. Stockpiling and changed demand patterns as a result of the coronavirus pandemic and various government measures could lead to steady or increased demand for certain products. For example, aseptic carton packaging manufacturer SIG Combibloc Group AG (SIG, Ba2 stable) has maintained its 6%-8% full-year revenue growth guidance and plastic packaging manufacturer Kleopatra Holdings 2 S.C.A (KP, B3 negative) also expects more demand for its products from macro developments, at least this year, as well as EBITDA growth. In this context, we recently maintained our stable outlook for the US packaging industry.

Some companies have faced or are currently facing production and logistical disruptions to the extent that the pandemic has led to factory closures, high levels of absenteeism or transport restrictions, hampering their ability to fulfill customers' orders and the overall quality of the service. Examples include companies such as Axilone, Albea Beauty Holdings S.ar.l. (Albea, B2 review for downgrade) and Guala Closures S.p.A. (B1 stable) which had their Chinese factories shut down for few weeks in February or had partial closures in their European sites since March, or Weener Plastics Holdings BV (Weener Plastics, B1 stable) which also experienced plant shut downs in some countries for several days. For the remainder of the European non-paper packaging companies we rate, operating disruptions have been limited. 

Increased foreign exchange volatility, particularly in emerging markets (see Exhibit 3), could also have an impact on earnings for some companies. These include Guala, which derives a material part of its revenue in Russia, Latin America (LatAm) and Africa and Weener Plastics, which generates 30% of its revenue in LatAm and Asia. SIG and Taghleef Industries Topco Limited (Taghleef, Ba3 stable) could also be affected because of their global presences and Verallia S.A. (Verallia, Ba3 positive) where Argentina, Brasil and Chile account for 10% of its revenue.

These operating challenges will hit rated European non-paper packaging companies' earnings for 2020 to a moderate degree (see Exhibit 4). While we expect revenue to decline by a low-single-digit percentage on average in 2020, versus our previous expectation of stable revenue, the reduction in EBITDA will be in the mid single-digit region despite accelerating cost-cutting measures and input cost savings. We estimate that the pandemic will hit Q2 revenue and profits and partly affect Q3 as well, but there will be a gradual recovery thereafter, in line with our expectations of a recovery in the economy. As Exhibit 5 shows, we expect leverage for the 15 companies we rate in the sector to increase as a result of lower EBITDA and higher debt drawdown from revolvers. -

Cost cutting measures will help to offset revenue volatility and preserve cash

We expect European non-paper packaging companies to implement a range of measures to help offset revenue declines caused by the coronavirus pandemic. However, cost control has always been a feature of the sector as packaging companies need to protect their margins from ongoing price pressure,We expect this focus on costs to increase in 2020. Companies will avoid or cut unnecessary costs, such as marketing and travel expenses, and will seek wage subsidies or government support where possible. The sharp declines in crude oil and metal prices (see Exhibits 6 and 7) will have knock-on effects leading to a decline in raw material and energy prices. This could result in a few months of positive impact on profits and lower inventories (in monetary terms) particularly in Europe, but the profit impact would likely be short-lived and more than offset by the impact of foreign currency volatility caused by the appreciation of the euro and the US dollar relative to emerging market currencies. Pass-through clauses are less common in Europe and even where they do exist there is time lag before they kick in. Some costs such as energy are often excluded from these arrangements.

Lower sales because of the coronavirus pandemic will support lower working capital needs for the full year. Also, we do not foresee payment delays because most non-paper packaging companies' customers are blue-chip consumer goods or beverage companies. Certain companies will also try to preserve cash by deferring nonessential capital investments. This is a key mitigant to the moderate loss in earnings that we expect.

Liquidity remains adequate across the cohort with material debt maturities beyond 2022

All European non-paper packaging companies have speculative-grade ratings; 12 out of the 15 companies are single-B rated. Access to liquidity is, however, critical for companies to manage the continuing deterioration in economic conditions. We recently lowered our 2020-21 real GDP forecasts for all G-20 advanced economies and now expect the euro area to shrink by 6.5% in 2020 compared with our previous forecast of a 2.2% contraction.

The liquidity of the companies in the sector is adequate, when considering the levels of cash and cash equivalents, committed and unused bank facilities and access to factoring programmes for near-term needs. Larger companies, such as ARD Finance S.A. (Ardagh, B3 stable) and Verallia, tend to address their liquidity needs and debt maturities well in advance. Overall, there is limited refinancing risk for the cohort. The debt maturities are managed beyond 2022, except for KP which will have to address upcoming maturities of bank loans in 2022.

Limited rating activity reflects the sector's low exposure

Of the five rating actions we have taken on the sector since the start of March 2020 (see Exhibit 9), only two were strictly related to the coronavirus pandemic. In April we changed the outlook on Axilone's B3 rating to negative from stable to reflect its limited and discretionary product offering and a production footprint in coronavirus affected countries (China, France and Spain).5 In May we downgraded Schoeller to B3 from B2 and maintained our negative outlook on the rating. This is because we are forecasting a deep recession in the US and Europe in 2020 and believe this will diminish demand for Schoeller's products, particularly in more vulnerable end markets such as auto and industrial manufacturing, with an effect on its earnings, cash flow generation and credit metrics.

In the case of Albea, the French personal care and beauty packaging manufacturer, we placed its B2 rating on review for downgrade on April 14 not only to reflect the potential volumes reduction from the virus, but also the uncertainty over its capital structure pending the decision on the use of proceeds from the disposal of Alinea. The change in outlook to negative on the B2 rating of German rigid plastic packaging manufacturer PACCOR Holdings GmbH's (PACCOR, B2 negative) was driven by its subdued performance compared with our expectations, increase in leverage and risk in achieving its planned EBITDA improvement even though we think the impact on its business from the coronavirus will be modest. Lastly, the downgrade of Ardagh's rating was mainly driven by the increase in gross leverage following its April 2020 bond issuance, although net leverage was unaffected.