Fitch Places Sequa Corp.'s Ratings on Positive Watch on Precoat Sale Announcement

Fitch Ratings has placed Sequa Corp.'s 'CCC+' Issuer Default Rating (IDR) and its long-term issue ratings on Rating Watch Positive.

This action follows the announcement that Sequa plans to sell its Precoat Metals business to AZZ Inc. for $1.28 billion, or around $1.13 billion of net proceeds.

The placement on Positive Watch reflects uncertainty regarding Sequa's long-term capital structure and strategy following the divestiture. Fitch expects that the company will use nearly all of the proceeds from the transaction to reduce its debt balance and improve its financial profile to a level more commensurate with the 'B' rating category, which would lead to an upgrade of the company's ratings to at least 'B-'. Sequa's weak credit metrics, limited financial flexibility and vulnerable FCF have been the main factors driving the 'CCC+' rating in recent years.

The transaction is anticipated to close by the end of May, at which point Fitch intends to resolve the Rating Watch.

Key Rating Drivers

Divesting Precoat: Sequa announced on March 7, 2022 that it plans to sell its Precoat business to AZZ Inc. for $1.28 billion, or around $1.13 billion of net proceeds. Fitch has historically viewed Sequa's Precoat business as a positive driver of the rating, offsetting aerospace aftermarket cyclicality with stable and high margin revenue, and a strong market position. Fitch believes materially reducing debt would offset the impact of Sequa losing its stronger performing segment and will likely lead to a positive rating action upon completion.

Sub-4x Leverage Forecast Post-Transaction: Fitch expects Sequa will use nearly all of the proceeds from the transaction to repay debt and reduce leverage. The agency projects the RemainCo will operate with between $300 million and $400 million of debt post-divestiture, leverage below 4x and coverage above 3x, a level more in line with at least the 'B' category. However, given the cyclicality of the aerospace market and lower diversification without Precoat, the company's operational profile is generally consistent with 'B' category characteristics.

Profitability Improving and Stabilizing: Fitch believes following the transaction the RemainCo will operate with mid-teen segment margins and generate neutral-to-positive FCF. The aerospace recovery is likely to continue through 2024-2025 and should provide stability to Sequa's operating and financial profiles, which have been strained over the past few years.

Technology Remains Important: Technology employed by Sequa subsidiary Chromalloy supports the parent's rating. The company has made significant progress integrating itself within customers' workflows to provide bespoke manufacturing solutions. This has resulted in more sticky relationships than Sequa has historically maintained. However, the company must continue to work to maintain these relations, as future innovation by competitors could severely affect its credit profile.

Weaker Diversification: Fitch views the divestiture of Precoat as weakening Sequa's diversification and heightening the company's overall cash flow risk profile. While these concerns are generally offset by the improving financial profile, we expect Sequa will be more susceptible to secular and cyclical aviation downturns than with Precoat. Approximately two-thirds of the overall business serves the aerospace market, with the majority of that related to aftermarket sales and services.

Derivation Summary

Sequa's credit metrics prior to the divestiture are in line with Fitch's expectations for a 'CCC+' rating. Leverage is high and comparable to similarly rated companies; liquidity and financial flexibility are limited; and the company has generated volatile but mostly negative FCF on average over the past few years. Fitch expects the company's metrics could improve marginally over the next few years depending on the shape of the recovery of the aerospace market.

Chromalloy faces pressure in the commercial aviation aftermarket business from OEMs and other like-sized or larger players, despite its various contract awards over the past few years. Fitch considers Chromalloy's technology to be supportive of the rating; however, future innovation by competitors could severely affect the Sequa's credit profile.