Fitch has assigned a ‘BBB’ rating to Reliance Steel & Aluminum Co.’s new issuance of $800 million of senior unsecured notes. The Rating Outlook is Stable. Reliance intends to use the proceeds to repay outstanding indebtedness under its revolving credit facility and its unsecured term loan.
The ratings reflect Reliance’s flexible and scalable operating model, stable operating margins through the cycle, strong working capital management, conservative financial policy, and its industry leading size and diversification. Reliance consistently generates solid FCF despite its exposure to cyclical end markets and volatile steel and aluminum prices. The company has a solid track record of growth through strategic acquisitions while demonstrating a strong commitment to an investment grade credit profile.
KEY RATING DRIVERS
Significant Size and Scale: Reliance is the largest metals service center company in North America, distributing more than 100,000 metal products to more than 125,000 customers in a broad range of industries. Fitch believes Reliance’s significant size and scale in a highly fragmented industry provides purchasing power and operating leverage, which drives a competitive advantage relative to peers.
Stable Margins: Fitch believes Reliance’s focus on small higher margin orders as opposed to larger volumes, minimal contractual sales, just-in-time inventory management and its commitment to pricing discipline supports its industry-leading margins. Despite having exposure to cyclical-end markets and volatile steel and aluminum prices, Reliance has been able to maintain stable gross profit margins, ranging between 25%-30% over the past 10 years. Gross profit margins have averaged around 29% since 2015, up from the 25%-27% range prior, driven by Reliance’s investment in higher value added services for its customers. In 2019, 51% of orders included value-added processing, and 40% of orders were delivered within 24 hours.
Counter-Cyclical Cash Generation: Reliance is consistently profitable and generates strong, stable cash flow through the cycle. Diversification by product, customer, geography and end markets reduces the company’s cash flow volatility. Reliance actively manages inventories and leverages its flexible scalable business model to optimize operational performance through all phases of industry and economic cycles. In periods of weakening demand or lower prices, Reliance is able to generate significant cash by effectively managing working capital. The company has historically used a portion of cash generated in recessionary environments to pay down debt, supporting its investment-grade profile.
Low Capital Intensity Operations: Capital intensity has averaged less than 2% over the last 10 years, and Fitch estimates maintenance capex of approximately $90 million-$100 million. Fitch forecasts slightly higher capital intensity over the next few years, averaging less than 3% of sales, driven by higher spending on value-added processing equipment. Reliance has invested over $950 million over the last five years with the majority of capex allocated to growth initiatives to promote gross profit margin expansion. Fitch views the company’s focus on increasing value-added processing capabilities as providing potential for further margin improvement.
Conservative Financial Strategy: Management has demonstrated a strong commitment to an investment-grade credit profile. Reliance’s largest acquisition was in 2013 when it acquired Metals USA Holding Corp. (MUSA) for $767 million in cash and $486 million in assumed debt, which resulted in total debt-to-EBITDA temporarily peaking around 2.7x. Reliance’s total debt/EBITDA ratio has since trended down to 1.5x as of March 30, 2020, and has averaged around 2x since its acquisition of MUSA. Fitch believes Reliance will continue to fund acquisitions and shareholder returns in a credit-conscious fashion and total debt/EBITDA will generally remain in the 2x-3x range.
Strong Acquisition Track Record: As of Dec. 31, 2019, Reliance has completed 67 acquisitions since its IPO in 1994, building a solid track record of acquiring profitable growth. The highly fragmented nature of the industry provides significant acquisition growth opportunities supporting Fitch’s expectation Reliance will continue to be a consolidator. Fitch believes Reliance will remain disciplined and selective in its approach, focusing on companies that enhance its diversification with an emphasis on higher margin specialty products and value-added processing services.
Reliance targets well-run companies that are available for sale, have experienced management teams, strong reputations, and that are immediately accretive with positive cash flow. Reliance enables acquired companies to continue to operate as stand-alone businesses to preserve existing customer relationships, but builds additional value through its significant scale, supplier relationships and access to capital.
Shareholder-Friendly Activity: On Oct. 23, 2018, the board of directors extended Reliance’s share repurchase program through Dec. 31, 2021, and increased the total number of authorized shares available for repurchase to 10.7 million. During 1Q20, Reliance made roughly $300 million in share repurchases, and has approximately 3.1 million shares available for repurchase under the program. Fitch believes the company will continue prioritize shareholder returns, but will likely fund repurchases with excess cash flow.
DERIVATION SUMMARY
Reliance’s operational profile compares similarly with metals service center company Ryerson Holding Corporation (B+/Stable) and chemical distributor Univar Inc. (BB/Positive). Reliance, Ryerson and Univar are similar in that they have a leading market share within their respective highly fragmented industries, similar underlying volumetric risk given exposure to cyclical end markets and low annual capex requirements. Reliance is considerably larger, has higher margins and has stronger leverage and coverage metrics compared with Ryerson and Univar. However, all three companies benefit from significant size, scale and diversification compared with their respective peers.
KEY ASSUMPTIONS
Fitch’s Key Assumptions Within Its Rating Case for the Issuer
–Volumes decline roughly 15% in 2020, rebound in 2021 and organic volume growth of around 1% thereafter;
–Selling prices bottom in 2020 and recover modestly throughout the forecast period;
–Gross profit margins average around 29%;
–Capex of around $250 million on average annually, slightly higher than historical spending driven by investment in increasing levels of value-added processing equipment;
–Acquisitions of roughly $200 million annually beginning in 2022;
–Share repurchases averaging around $250 million annually beginning in 2021.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to a positive rating action/upgrade:
–Total debt/EBITDA sustained below 2.0x;
–Total adjusted debt/EBITDAR sustained below 2.5x;
–Gross margins sustained at or above 30% driven by increasing levels of value-added processing.
Factors that could, individually or collectively, lead to a negative rating action/downgrade:
–Total debt/EBITDA sustained above 3.0x;
–Total adjusted debt/EBITDAR sustained above 3.5x;
–Gross margins sustained below 25%.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.