Fitch Ratings has affirmed Tarkett Participation's Long-Term Issuer Default Rating (IDR) at 'B+' with a Stable Outlook and senior secured debt at 'BB-' with a Recovery Rating of 'RR3'.
The rating affirmation and Stable Outlook reflect Tarkett's stronger credit metrics compared with our previous expectations, which are now well within rating sensitivities. We believe expected margins and leverage in the next two years have sufficient headroom to counterbalance weak demand in 2024 across Tarkett's main regions/segments, except for sport flooring, which has strong revenue growth and improving margins. The rating remains constrained by weaker operating profitability than the sector and limited free cash flow (FCF).
The rating is supported by Tarkett's leading market positions across a number of product segments and markets, strong diversification, a sound split between renovation and new build, and between commercial and private residential end-customer segments.
Key Rating Drivers
Improving Leverage: Tarkett's EBITDA gross leverage was 5.4x in 2023 (versus 6.1x forecast a year ago). This improvement was largely due to faster than expected repayment of drawings on the revolving credit facility (RCF), supported by better inventory management and higher EBITDA. Fitch forecasts further deleveraging to below 4.6x in 2024 and 4.3x in 2025, well below our previous expectations of 5.7x and 5.0x. We believe Tarkett's recent profitability improvement ensures a comfortable liquidity position and leverage headroom to counterbalance weak demand for the building products in 2024, before it recovers on a sustained basis.
Margins Below Peers, Albeit Improving: Tarkett's margins continue to lag its Fitch-rated building products sector peers, which we view as a constraint for the rating. However, Fitch-adjusted EBITDA margins improved to 6.5% in 2023 from 5.5% in 2022 mostly due to cost cutting and normalised raw material prices.
We expect Tarkett's margins to trend towards 7.6% in the next two years, as inflationary pressures ease and efficiency measures crystallise, which is set against low double-digit margins for peers. The weaker margins reflect Tarkett's less niche product mix, the lower-margin North America segment (compared with historical margins although gradually improving), lower margins in Europe due to weak demand and a fairly long lag to pass through higher prices on customers.
FCF to Stabilise: Fitch expects free cash flow (FCF) margins to stabilise at around 1.6% in 2024-2025.. We believe it will be supported by higher EBITDA, lower interest payments, no dividend payments, and stable capex intensity at 2.8% of sales. We view working capital discipline as critical for positive FCF generation, with continued disciplined inventory management as a key element.
Sector Demand Remains Challenging: Fitch expects the demand for building products to remain weak in 2024 with some exceptions across certain niche products or end-markets. Tarkett is strong in sport flooring and benefits from high demand, particularly in North America, which counterbalances weak volumes in other segments. Residential demand will remain weak in Europe, where Tarkett generates a quarter of its revenue, partly from residential flooring, before monetary easing rebuilds consumers' disposable income and confidence.
Fitch believes Tarkett's sound diversification with high exposure to renovation and to more resilient commercial education and healthcare flooring will mitigate weak residential demand in 2024. However, we expect downward pricing pressure as prices of raw materials have significantly declined since the 2022 peak.
Russian Operations Contained: Sanctions imposed by the West at the outbreak of the Russian war put pressure on Tarkett's profitable Russian operations. The Russian business is mainly produced and sourced locally, the economy and rouble exchange rate against the euro remain uncertain. The limitations on repatriating cash from Russia is not a material risk as to date cash flow generated has been partly retained in Russia to manage local operations and partly remitted to the group. However, we consider Tarkett's exposure to Russia in our peer comparison, rating sensitivities and Recovery Rating analysis.
Raw Material Sensitivity: Tarkett is exposed to raw-material cost swings, notably of oil-based derivatives PVC, plasticisers and vinyl. It suffers from a fairly long lag in passing on cost inflation to its customers. Commercial projects can have up to one year between order and delivery as floor installation is at a late stage of project construction.
Tarkett has now been able to offset the inflation impact arising from raw materials increases in 2022, generating a positive inflation balance in 2023 with fairly strong prices and cheaper raw materials. We believe recent purchase optimisation and tight cost control will support further margin recovery.
Balanced End-Market Diversification: Tarkett's business profile benefits from an 80/20 split between the more stable renovation market versus the potentially more volatile new-build market. The flooring renovation cycle is quite frequent, with office space in particular generally changing flooring with every new tenant or lease contract. Its 75/25 split between commercial and private residential allows Tarkett to benefit from different demand drivers.
Derivation Summary
Tarkett's closest rated peer is Hestiafloor 2 (Gerflor, B/Stable), which has fairly similar product offerings of vinyl and linoleum flooring for primarily commercial end-customers. Gerflor is smaller, about a third in turnover with fairly high exposure to France, but has better EBITDA margins (12%-13%) than Tarkett (7%-7.5%). Victoria PLC (BB-/Stable), which targets the residential flooring segment mostly in Europe, is also smaller and generates higher EBITDA margins (around 12%-14%) than Tarkett in the next two to three years.
Other peers include the largest flooring company globally, US-based Mohawk Industries, Inc. (BBB+/Stable) and building products company Masco Corporation (BBB/Stable). These companies are more than twice Tarkett's size, and have higher exposure to residential end-customers. Mohawk is large also in ceramic tiles and Masco's offering spans a portfolio of home-improvement building products.
Tarkett's expected EBITDA gross leverage of 4.6x-4.3x in 2024-2025 is stronger than that of lower rated Gerflor's (5.8x -5.5x) and PCF GmbH's (B/Stable) with EBITDA gross leverage of 6.4x-6.0x in the same period. EBITDA gross leverage of higher rated Victoria is stronger than that of Tarkett's with 4.1x-3.2x expected by Fitch at the financial year ending March 2024 and 2025.
Key Assumptions
Revenue to increase by 1.2% in 2024 and 2.9% in 2025 on expected demand recovery, and by 1.4% in 2026
EBITDA margin at 7.4% in 2024, 7.6% in 2024 and 2025, reflecting easing inflation and cost control
Capex at around 2.8% of sales
Cost of debt benefiting from hedges until end-2026
No dividends assumed over the rating horizon
No buyback of the remaining 9.6% of shares
Recovery Analysis
The recovery analysis assumes that Tarkett would be reorganised as a going concern in bankruptcy rather than liquidated.
A 10% administrative claim.
The RCF is fully drawn in a post-restructuring scenario according to Fitch's criteria. The factoring line is ranked super senior (deducted from estimated enterprise value). Senior unsecured debt consists of overdraft facilities and other bank loans, which rank behind senior secured debt.
The going-concern EBITDA estimate of EUR155 million reflects our view of a sustainable, post-reorganisation EBITDA upon which we base the valuation of the company.
An enterprise value multiple of 5.5x is used to calculate a post-reorganisation valuation. It reflects Tarkett's leading position in its niche markets (such as sport or resilient flooring and commercial carpets in western Europe and Russia or wood flooring in the Nordics), long-term relationship with clients and an 80% revenue share in the renovation segment, limiting its exposure to more volatile new-build projects.
The waterfall analysis output for the senior secured debt (term loan B of around EUR900 million) generated a ranked recovery in the 'RR3' band, indicating an instrument rating of 'BB-'. The waterfall analysis output percentage on current metrics and assumptions was 52%.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
EBITDA margin above 8% on a sustained basis
FCF margins sustainably above 2% on a sustained basis
EBITDA gross leverage below 4.0x (revised down to reflect updated peer comparison including Tarkett's profit margins) on a sustained basis
Factors that could, individually or collectively, lead to negative rating action/downgrade:
EBITDA margin below 6%
Negative FCF
EBITDA gross leverage above 6.0x
EBITDA interest coverage below 3.0x
Liquidity and Debt Structure
Comfortable Liquidity: At end-2023 the company had EUR122 million of Fitch-adjusted cash and EUR350 million of the undrawn RCF with maturity in 2027. Fitch's cash adjustments include 1% of sales to cover intra-year working capital changes and cash held in Russia and Ukraine. The company's liquidity position is supported by no dividend payments, limited M&A activity, modest capex requirements and no major debt amortisation scheduled in the next three years. We forecast positive FCF generation at around 1.6% of revenues in 2024-2025.
Long Debt Maturity Profile: The capital structure includes four 'Schuldschein' tranches with EUR34 million outstanding (as of December 2023) and the longest maturity in 2025, amortising loans with outstanding amount of EUR36.7 million (December 2023) and the longest maturity in 2027, the bond loan of EUR31.5 million with the maturity in 2031, the RCF with maturity in 2027 and term loans B of EUR839.2 million and USD72 million with maturity in 2028. We believe the refinancing risk for all minor debt items is low, while for the largest debt portion due in 2028 it is mitigated by improving key credit metrics.
Issuer Profile
Tarkett is a leading flooring and sports surface manufacturer offering solutions to the healthcare, education, housing, hotels, offices, commercial and sports markets. Products include vinyl, linoleum, carpet, rubber and wood flooring as well as synthetic turf and athletics track.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
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