In our opinion, these positive factors are offset by PERI's exposure to significant volatility of demand through the construction cycle, its limited diversity by product line and end market, the limited predictability of its future performance, and the fixed-capital intensity of the business due to rental activities.
S&P base-case operating scenario
We believe that PERI will likely show mid single-digit sales growth in 2012. This is partly supported by the group's acquisition of its long-term distribution partner in South Africa, which should add about EUR35 million in sales in 2012 (or 4% of 2011 revenues). We assume the group will experience a single-digit revenue decline in 2013, owing to challenging economic conditions in Europe (see "Economic Research: The Curse Of The Three Ds: Triple Deleveraging Drags Europe Deeper Into Recession," published on June 30, 2012). We consider the group's revenues to be rather late-cyclical, owing to its exposure to the construction industry. We believe PERI will be able to balance declines in its Western European markets with growth in emerging markets and to a lesser extent in the U.S.
In our base-case scenario, we assume that PERI's adjusted EBITDA margin will decline from its highs of close to 31% for 2011 due to pricing pressure in competitive construction markets. In addition, we expect investment in international expansion to create some ramp-up costs and potentially a negative product mix effect to put additional pressure on the adjusted EBITDA margin, which we expect to decline to about 28% in 2012 and in 2013.
S&P base-case cash flow and capital-structure scenario
We anticipate that PERI's financial metrics will remain solid in the next two years, comfortably above levels we consider commensurate with the current rating. This should leave some cushion for a more significant weakening of operating conditions than currently assumed. We expect funds from operations (FFO) to debt will be between 40% and 45% in 2012 and 2013, which we consider solid for the rating. We expect the drop in 2013 on 2012 to be caused largely by an increase in leverage due to significant expansionary investments, mostly related to investments in the rental fleet, but also due to some expansionary investment to improve the group's footprint in emerging markets.
We assume the group will continue with its moderate financial policy, with limited dividend payouts and a continued focus on organic growth. However, we expect that capital spending will increase from the 2009 and 2010 levels, when PERI slowed its expansion following heavy investments in the years before the downturn in 2009 (running at more than 25% and 30% of sales in 2006 to 2008). We note that there is a large discretionary element in PERI's investments that it could avoid in a contracting operating environment. We expect that debt to EBITDA will remain below 2.5x in 2012 and 2013, which we would view as rating-commensurate.
We assess PERI's liquidity as "adequate", according to our criteria. Our credit scenario shows that in the 12 months starting July 1, 2012, liquidity sources will surpass needs by above 1.2x. For the subsequent 12 months, that ratio is above 1x.
Liquidity sources include:
-- A recently signed EUR350 million syndicated committed revolving credit facility (RCF) due in 2017. This facility follows a EUR460 million syndicated line it had in place previously. We understand that about EUR240 million of its previous RCF was undrawn as of June 30, 2012, indicating pro forma headroom of about EUR130 million under the new facility.
-- FFO comfortably above EUR200 million for the coming years.
Liquidity needs include:
-- Investment needs for maintenance capital expenditures and expansionary investments, including investments needs for the rental fleet; and
-- Cumulative working capital needs of about EUR40 million to EUR45 million over the coming two years.
Given the capital intensity of the business and its seasonal business model, we consider a liquidity cushion of at least EUR100 million throughout the year as commensurate with an "adequate" liquidity position. We note management's generally proactive attitude to managing the group's maturity profile. We also believe there is ample financial flexibility in PERI's business model given its ability to curtail expansionary capital spending when demand slows, as demonstrated in 2009 and 2010.
PERI's credit facilities and bond agreements include financial covenants, a material adverse change clause, and a change of ownership clause, but no rating triggers. According to our calculations, PERI will remain in compliance with its financial covenants, with what we consider to be adequate headroom.
The stable outlook reflects our view that PERI's financial position has sufficient headroom to withstand a moderation of demand and to absorb heavy expansionary investments thanks to the company's "satisfactory" business profile, characterized by its competitive products and services, vast geographic diversity, and good profitability. We believe the group will be able to maintain a ratio of adjusted FFO to debt of about 30% and a ratio of adjusted debt to EBITDA of about 2.5x, which are both commensurate with the current rating.
We could revise the outlook to negative or lower the rating if, among other reasons, operating profitability declined significantly as a result of intensifying pricing pressure or if the group failed to control expansionary investments that could result in a significant increase in financial leverage. Downward pressure on the rating could arise if the group's reported EBITDA margin were to drop below 24% coupled with a rise in its capital spending-to-sales ratio above those of 2007 and 2008, when PERI was spending more than 30% of group revenues. We see this scenario as relatively unlikely.
Ratings upside is limited, in our view, given the high capital intensity of the group's rental fleet and its relatively low business diversity. We think this capital intensity limits the near- to medium-term likelihood of that the group will materially strengthen and sustain its financial risk profile.