TEXT-Fitch cuts Navistar's IDR to 'BB-'
June 22 - Fitch Ratings has downgraded the long-term IDRs for Navistar International Corporation (NAV) and Navistar Financial Corporation (NFC) to 'BB-' from 'BB'. The ratings remain on Rating Watch Negative. A full rating list is shown near the end of this release. The downgrade reflects: --Heightened risks surrounding certification of NAV's emissions compliant engines; --Higher than anticipated warranty costs on engines; --Delayed improvement in NAV's market share of medium and heavy duty trucks in the U.S. and Canada; and --Low margins. These developments contributed to a material loss in first half-2012 (1H'12) and could pressure NAV's cash flow and liquidity. Manufacturing debt/EBITDA increased materially, to slightly above 4 times (x) at April 30, 2012, from 2.4x at Oct. 31, 2011. Fitch believes this level may remain elevated compared to recent levels. Fitch expects to resolve the Negative Rating Watch after the Environmental Protection Agency (EPA) determines whether or not NAV's EGR engine technology meets emissions requirements. If certification is denied or substantially delayed, NAV's competitive position and financial performance could be impaired, and the company may be required to reconsider its engine strategy. NAV's ratings may remain at heightened risk for a downgrade if warranty costs don't stabilize and eventually improve. Other possible factors that may precipitate a downgrade are if free cash flow doesn't recover sufficiently to support liquidity, or if NAV encounters additional execution issues with respect to its integration strategy and expansion overseas. In addition, activist investors have accumulated approximately 25% of NAV's common shares in recent months. This introduces some uncertainty about long term operating and financial policies. Conversely, Fitch may resolve the Negative Rating Watch with an affirmation if NAV's emission compliant engines receive timely certification by the EPA. Also supporting a possible future rating affirmation will be if engine quality improves materially, operating margins improve, NAV manages commodity costs effectively, and the company's market share recovers. Weak financial performance reported by NAV in 1H'12 reflected large warranty charges, higher commodity costs for steel and rubber and the negative impact of lower sales of military trucks and parts. Also factoring into the performance were weaker results in Brazil associated with engine pre-buying in 2011 and a transition to contract engine manufacturing for a large customer, start-up and restructuring costs in certain businesses. Other factors included ongoing consolidation of engine and truck engineering operations, and the relocation of NAV's headquarters. NAV's performance could improve during 2H'12 due to seasonality, operating improvements associated with ongoing integration and restructuring actions, and the elimination of special warranty charges (largely non-cash) and certain one-time costs. However, Fitch believes NAV will be challenged to achieve profitability for the full year. Fitch views NFC as neutral to the rating. NFC is performing as expected by Fitch, including steady progress with respect to capitalization and asset quality. NAV's market share for medium and heavy duty trucks in the U.S. and Canada has been slow to improve. The delay can be partly attributed to NAV's strategy of producing its own engines which it initially introduced at a measured pace. In addition, there are possible customer concerns about NAV's emissions compliant engines surrounding engine quality and delayed certification by the EPA. NAV estimates emission credits will run out for heavy duty engines in 2012 and medium duty engines in 2013. Manufacturing free cash flow (FCF) in 1H'12 was negative $388 million. This reflected low margins and capital expenditures which remain higher than average as NAV integrates its engineering functions, invests in a research center and engine testing facility, and realigns other parts of its business. Fitch estimates FCF could break even or be slightly positive in 2H'12, though it will remain negative for the full year. Fitch's estimate assumes NAV's emission compliant engines are certified in the near term. This would allow NAV to continue selling its heavy duty engines. NAV's manufacturing FCF is constrained by recurring pension contributions. NAV's net pension obligations totaled $1.8 billion (approximately 57% funded) at the end of 2011. NAV expects to contribute $190 million to the plans in 2012. Of this amount, $82 million was contributed during the first half of the year. Between 2013 and 2015, NAV estimates it will be required to contribute at least $210 million annually. Liquidity is currently adequate. However, it could become a concern if performance doesn't improve, or if temporary cash requirements, such as higher working capital requirements for used-truck inventories, do not reverse. At April 30, 2012, Navistar's liquidity, excluding NFC, included $681 million of cash and marketable securities. This is down from nearly $1.2 billion at Oct. 31, 2011, and $192 million of availability under a $355 million asset-based credit facility ('ABCL') that matures in 2016. In June 2012, NAV borrowed an additional $138 million under the ABCL. Liquidity is offset by $230 million of manufacturing debt due within one year. NAV repurchased a combined $200 million of shares in fiscal 2011 and the first half of fiscal 2012. Fitch anticipates further repurchases will be minimal in the near to medium term until NAV resolves concerns about engine certification and low margins. NFC's financial performance is generally in line with Fitch's expectations. Profitability has declined slightly in the six-months ended April 30, 2012 due to the run-off of NFC's retail portfolio. The retail balance is expected to decline further over the next several years due to NFC's agreement with GE Capital in 2010 as the primary funding source for the company's retail portfolio Asset quality continues to improve and provisioning volatility has declined as NFC focuses on its relatively lower risk wholesale portfolio. NAV's capitalization is consistent with similarly rated captives, and Fitch expects leverage to improve and stay below historical levels due to reduced financing needs as a result of NFC's exit from retail financing. In fourth quarter-2011, NFC completed a significant refinancing of its credit facilities. Fitch believes the refinancing of its credit facilities may mitigate any potential near-term liquidity concerns. Due to NFC's close operating relationship and importance to the parent, its ratings are directly linked to those of the ultimate parent. The relationship is governed by the Master Intercompany Agreement. There is a requirement referenced in the NFC credit agreement requiring Navistar, Inc. or NAV to own 100% of NFC's equity at all times. Fitch's ratings cover approximately $2 billion of debt at NAV and $2.5 billion of outstanding debt at its Financial Services segment, the majority of which is at NFC, as of April 30, 2012. Fitch has downgraded the ratings for NAV and NFC as follows: Navistar International Corporation --Long-term IDR to 'BB-' from 'BB'; --Senior unsecured notes to 'BB-' from 'BB'; --Senior subordinated notes to 'B' from 'B+'. Cook County, Illinois --Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'BB-' from 'BB'; Illinois Finance Authority (IFA) --Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'BB-' from 'BB'; Navistar Financial Corporation --Long-term IDR to 'BB-' from 'BB'. --Senior unsecured bank credit facilities to 'BB-' from 'BB'. The ratings remain on Rating Watch Negative. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 12, 2011); --'Finance and Leasing Companies Criteria' (Dec.12, 2011); --'Rating Linkages in Nonbank Financial Subsidiary Relationships' (Nov. 29, 2011); --'Global Financial Institutions Rating Criteria' (Aug. 16, 2011). Applicable Criteria and Related Research: Corporate Rating Methodology Finance and Leasing Companies Criteria Rating Linkages in Nonbank Financial Subsidiary Relationships Global Financial Institutions Rating Criteria
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