DBRS Confirms NOVA Chemicals at BBB (low), Stable Trend

DBRS has today confirmed the Unsecured Notes & Debentures rating of NOVA Chemicals Corporation (NOVA or the Company) at BBB (low) with a Stable trend. The confirmation of the rating still primarily relies on the implied support provided by NOVA’s parent, International Petroleum Investment Company (IPIC), which is wholly owned by the Government of the Emirate of Abu Dhabi (details below). NOVA’s operating performance continued to improve and was above expectation in 2011. However, on a stand-alone basis, the Company’s risky business profile and aggressive balance sheet is still not compatible with a BBB (low) rating.

Nova continued to benefit from favourable operating conditions in 2011 and all of its businesses were profitable, especially the ethylene operation at Joffre, Alberta (Joffre). The combination of lower feedstock (natural gas) costs, higher product prices and modestly higher utilization rate contributed to a significant increase in earnings at Joffre. NOVA benefited from an unprecedented decline in natural gas prices. The development of shale gas has sharply increased gas supply in the continent. However, an inadequate infrastructure in the industry has limited export opportunities for the surplus gas, resulting in a significant oversupply condition and the resultant sharp decline in prices. This development has sharply lowered the feedstock cost at Joffre.

Near-term market conditions are expected to stay largely unchanged, with the demand for ethylene and polyethylene to track the modest growth of North American economic conditions. A lack of capacity expansion in the past decade maintains a balanced to slightly tight demand/supply conditions. Additionally, the continued growth in natural gas supply bodes well for feedstock cost at Joffre. However, the flip side of low gas price would be a decline in supply from conventional sources, and NOVA has been actively seeking out a new source of ethane supply. DBRS believes that NOVA’s recent efforts to diversify its source of feedstock have adequately addressed the supply concerns. However, the Corunna, Ontario, site (Corunna) will not be able to receive full benefit of the low gas price situation until its flexi-cracker conversion is completed at the beginning of 2014. Hence, DBRS expects NOVA’s operating results in 2012 to show gradual improvement on a year-over-year basis with Joffre contributing the bulk of the earnings.

The Company’s financial profile strengthened, operating results improved and all debt and interest coverage ratios were within the current rating range in 2011. The Company has repaid $400 million in maturing debt in the first quarter of 2012 with cash-on-hand and, on a pro forma basis, the adjusted debt leverage declined to 47% from over 51% at the end of 2011. Despite the deleveraging efforts since 2009, the balance sheet is still aggressive for a company with a volatile business risk profile like NOVA. DBRS expects the Company to continue to generate near $1 billion of cash flow from operations in 2012, similar to the previous year’s level. However, investment on projects, such as converting the flexi-cracker at Corunna and capacity expansion at the polyethylene plants, amongst others, is expected to almost double capital expenditures. Nevertheless, DBRS still expects the Company to be able to meet these funding needs internally and to generate free cash flow.

Despite a stronger financial profile, the rating is still highly influenced by the implied support of IPIC. A formal guarantee has not been provided to NOVA bondholders, but DBRS expects that IPIC would provide financial support to NOVA in the event of potential distress. IPIC’s actions to date – such as the conversion of loan into equity and the decision to allow NOVA to retain its free cash flow for debt reduction and to bolster its liquidity – are viewed as strong evidence of support. Without this implied support, the Company would likely be rated in the upper range of the BB category, given the highly cyclical nature of the commodity chemicals industry, which has contributed to significant earnings and cash flow volatility, and NOVA’s still aggressive balance sheet. The Company has to lower its leverage, on an adjusted basis, to below the 40% level and demonstrate that credit metrics achieved in the last two years are sustainable through a cycle before the Company would be compatible with the current rating on a stand-alone basis. Nevertheless, DBRS expects the Company’s rating to remain stable in the foreseeable future.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Industrial Products Industry, which can be found on our website under Methodologies.