TEXT-Fitch revises Meritor outlook to positive

Mon Feb 6, 2012 10:14am EST

Fitch Ratings has affirmed the 'B' Issuer Default Rating (IDR) and the various
issue ratings of Meritor, Inc. (MTOR) and revised the company's Rating
Outlook to Positive from Stable. A full list of the rating actions taken on MTOR
is included at the end of this release. MTOR's ratings apply to a $441 million
secured revolving credit facility and $1.1 billion of senior unsecured notes.	
	
The revision of the Rating Outlook to Positive is driven by Fitch's expectations
of further strengthening in MTOR's credit profile over the medium term as end
market demand solidifies, margins grow on stronger pricing and improved
manufacturing efficiencies, and leverage declines on higher EBITDA and lower
debt. Demand in all three of the company's core segments, Commercial Truck,
Industrial and Asia Pacific, and Aftermarket and Trailer, will be supported by
global economic growth, although weakness in Europe will negatively affect near
term demand in that region. MTOR's defense-related business is also expected to
rebound over the next year, as production of the U.S. military's Family of
Medium Tactical Vehicles (FMTV) program continues to ramp up with a new primary
contractor. Despite the improving business conditions, however, free cash flow
is likely to be weighed down by higher pension contributions and relatively
heavy capital spending, although Fitch expects full-year free cash flow to be
positive in fiscal 2012.	
	
During fiscal 2011, MTOR completed the sale of its remaining Light Vehicle
Systems (LVS) operations. In the past, the LVS business had put significant
pressure on MTOR's profitability, and Fitch expects the company's margins to
generally improve now that it is fully focused on the commercial truck and
industrial markets. Although the LVS divestiture is expected to be a long-term
positive for MTOR's credit profile, Fitch notes that commercial truck and
industrial demand tends to be much more volatile than auto demand, as evidenced
by the 67% decline in North American commercial truck production that was seen
between 2006 and 2009. Western European commercial truck production declined 64%
between 2008 and 2009. As such, Fitch notes that there is likely to be a greater
level of volatility in MTOR's operating profile through the economic cycle,
which will require the company to maintain sufficient liquidity access to
maintain its financial flexibility in a downturn.	
	
MTOR's liquidity position at Dec. 31, 2011 was relatively strong and included
$211 million in cash and cash equivalents. Liquidity is bolstered further by
access to a $441 million secured revolving credit facility and an accounts
receivable securitization facility with up to $125 million in availability,
depending on the level of eligible receivables. Combined with Fitch's
expectation for modestly positive free cash flow in 2012 and proceeds from
non-core asset sales, MTOR is projected to have sufficient liquidity to repay
its $84 million debt maturity that comes due in March, while still providing
enough financial flexibility following the debt payment to meet the company's
operational needs if global demand trends weaken significantly later this year.	
	
Free cash flow in the 12 months ended Dec. 31, 2011, was negative $16 million,
as heavy working capital usage tied to volume growth drove operating cash flow
down to $95 million, while capital spending rose to $111 million as the company
invested in efficiency and growth initiatives. As noted earlier, Fitch expects
MTOR to produce positive free cash flow in fiscal 2012, however, as margins grow
on improved pricing and the company gains further traction on manufacturing
efficiencies. In particular, premium costs tied to capacity shortages that were
incurred in fiscal 2011 are expected to decline significantly going forward, as
recently completed facility and equipment investments come on line. Margins also
should be supported in fiscal 2012 by increased FMTV business, which tends to
carry relatively strong margins. Nonetheless, free cash flow will remain under
pressure from capital spending that will be roughly flat with the fiscal 2011
level and higher required contributions to the company's pension plans.
Relatively high prices for raw materials, particularly steel, could also put
some pressure free cash flow, although this will be mitigated by revised cost
recovery mechanisms that the company finished enacting with its commercial truck
customers during the first fiscal quarter of 2012.	
	
As of Dec. 31, 2011, the face value of MTOR's balance sheet debt stood at $1.1
billion, about flat with the year-earlier period, although higher EBITDA
resulted in stronger credit protection metrics. Fitch's calculation of leverage
(balance sheet debt/Fitch-calculated EBITDA) was 4.0 times (x) at Dec. 31, 2011,
down from 5.7x at Dec. 31, 2010, as Fitch-calculated EBITDA grew 43% to $278
million from $194 million. EBITDA interest coverage also strengthened over the
period, rising to 3.0x from 1.8x. Fitch notes that its calculation of EBITDA
differs from the MTOR's 'Adjusted EBITDA' calculation primarily in that Fitch's
figures do not include equity in earnings of affiliates, while MTOR includes
those earnings in its adjusted calculation. Equity in earnings of affiliates
totaled $72 million in the 12 months ended Dec. 31, 2011. Fitch expects credit
metrics to continue strengthening through fiscal 2012, as the company retires
its $84 million note maturity and EBITDA increases. Fitch projects that leverage
could fall below 3.0x by the end of fiscal 2012 if global economic conditions
remain positive. In addition to its balance sheet debt, MTOR has several
off-balance sheet factoring and securitization programs that it utilizes. As of
Sept. 30, 2011, MTOR had utilized $279 million of off-balance sheet program
availability, of which $271 million was through committed facilities with banks.	
	
MTOR's pension plans are substantially underfunded. As of Sept. 30, 2011, the
company's global plans were 71% funded, with a shortfall of $557 million. In the
U.S., however, the company's pensions were only 63% funded, with a projected
benefit obligation that exceeded the value of plan assets by $455 million. The
substantial underfunded position of the company's pension plans remains a risk,
as low interest rates and the company's election to utilize the funding relief
provided by the Pension Relief Act of 2010 in the U.S. will translate to
significantly higher required cash contribution levels over the next several
years. In fiscal 2011, MTOR contributed $35 million to its global plans
(including $4 million tied to the pensions of discontinued operations), of which
only $5 million was contributed to the U.S. plans. For fiscal 2012, the company
has projected that contributions to its global plans will rise to $75 million,
and contributions in fiscal 2013 will increase further as the company makes
catch up payments to offset the pension relief deferrals taken in fiscal 2011
and 2012. Over the longer term, a rise in interest rates would help to reduce
MTOR's pension contribution requirements, although there would be a lag of over
one year before any increase would result in a decline in required
contributions.	
	
Volatility in raw materials prices is an inherent risk in MTOR's business.
Although the company has traditionally passed these costs through to its
customers, there historically has been a lag of up to one year before the
company's prices adjusted, which resulted in near-term margin pressure when
materials prices were rising. With the significant rise in materials prices over
the past year, MTOR entered into temporary agreements with many of its customers
to adjust pricing on a more frequent basis. During the first quarter of fiscal
2012, the company completed the transition of its commercial truck agreements to
revised escalator mechanisms that essentially made last year's temporary
agreements permanent. This change will result in more-frequent pricing
adjustments based on changes in raw materials costs, which will help to mitigate
margin pressure arising from rapid increases raw materials costs.	
	
The rating of 'BB/RR1' on MTOR's secured credit facilities reflects their
substantial collateral coverage and outstanding recovery prospects, in the 90%
to 100% range, in a distressed scenario. Collateral for the revolver includes
hard assets, accounts receivable, intellectual property and investments in
certain subsidiaries. As of Sept. 30, 2011, MTOR valued the assets backing the
facility at $671 million. The rating of 'B-/RR5' on the company's unsecured
notes reflects Fitch's expectation that recoveries on the notes would be below
average, in the 10% to 30% range, in distressed scenario. The lower level of
expected recovery for the unsecured debt is due to the substantial amount of
higher-priority secured debt in the MTOR's capital structure, including the
potential for a full draw on both the secured revolver and the U.S. accounts
receivable securitization facility.	
	
MTOR's ratings could be upgraded in the intermediate term if market conditions
remain stable and continued revenue and margin growth lead to increased free
cash flow stronger credit protection metrics. Fitch could undertake a negative
action on MTOR if market conditions deteriorate significantly, resulting in a
meaningful erosion of the company's liquidity and a substantial weakening of its
credit profile.	
	
Fitch has affirmed the following ratings on MTOR:	
	
--IDR at 'B';	
--Secured credit facility rating at 'BB/RR1';	
--Senior unsecured rating at 'B-/RR5'.	
	
The Rating Outlook is revised to Positive from Stable.	
	
Contact:	
	
Primary Analyst	
Stephen Brown	
Senior Director	
+1-312-368-3139	
Fitch, Inc., 70 West Madison Street, Chicago, IL 60602	
	
Secondary Analyst	
Craig D. Fraser	
Managing Director	
+1-212-908-0310	
	
Committee Chairperson	
Bill C. Densmore	
Senior Director	
+1-312-368-3125	
	
Additional information is available at 'www.fitchratings.com'. The ratings above
were unsolicited and have been provided by Fitch as a service to investors.	
	
Applicable Criteria and Related Research:	
--'Corporate Rating Methodology' (Aug. 12, 2011);	
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers'
(May 12, 2011);	
--'Evaluating Corporate Governance' (Dec. 13, 2011).	
	
Applicable Criteria and Related Research:	
Corporate Rating Methodology	
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers	
Evaluating Corporate Governance