TEXT-S&P cuts Federal-Mogul Corp rating to 'B'
Overview -- European original equipment market weakness and unfavorable aftermarket trends, including lower volumes and pressure on margins, are hurting U.S.-based auto supplier Federal-Mogul Corp.'s operating performance. -- We are lowering our corporate credit rating on Federal-Mogul to 'B' from 'B+'. -- We are also lowering our issue-level ratings on the company. -- The negative outlook reflects looming refinancing risk because the vast majority of the company's capital structure matures in the next three years--the revolver in December 2013 and funded term loans in December 2014 and 2015. Rating Action On Oct. 25, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Southfield, Mich.-based Federal-Mogul to 'B' from 'B+'. The outlook is negative. At the same time, we lowered the issue-level ratings on the company's senior secured revolving credit facility to 'BB-' (two notches above the 'B' corporate credit rating) from 'BB'. The recovery rating remains '1', indicating our expectation that lenders would receive very high (90% to 100%) recovery in the event of a payment default. We also lowered our issue ratings on Federal-Mogul's term loan B and term loan C to 'B' (the same as the corporate credit rating) from 'B+'. The recovery ratings remain '4', indicating our expectation that lenders would receive average (30% to 50%) recovery in the event of a payment default. Rationale The downgrade reflects the company's weaker-than-expected sales and operating performance, partly because of European market weakness, but also industrywide challenges in the aftermarket segment. We now view the financial risk profile as "highly leveraged," with debt to EBITDA (adjusted to include underfunded pensions and operating leases) approaching 7x. Additionally, free cash flow remains negative as a result of longer accounts receivable terms with its aftermarket customers. Even when these receivables are collected, as we expect, long-dated receivables are now a prominent feature of aftermarket sales to the large retailers. The negative outlook reflects our view that the company will need to undertake refinancing in a fragile economic environment with likely uncertain financial market conditions in 2013. The currently unfunded revolving credit facility expires in December 2013 and the term loans mature in December 2014 and 2015. We think it is not likely that lenders would extend the maturity of the revolver past the existing loan maturity. The ratings on Federal-Mogul reflect its highly leveraged financial risk profile and "weak" business risk profile as a major participant in the cyclical and highly competitive global auto industry. Standard & Poor's business risk assessment incorporates the multiple industry risks facing automotive suppliers, including volatile demand, high fixed costs, and severe pricing pressures. We believe intermediate-term financial prospects can support the 'B' rating despite elevated leverage. We believe light-vehicle production in North America should rise this year and next, although we expect that economic activity will remain weak in Europe and Latin America in 2013. Additionally, we expect the company will generate some positive free operating cash flow in 2013, as the longer-dated accounts receivable terms from Federal-Mogul's aftermarket customers is currently reaching a plateau. We believe Federal-Mogul's controlling investor, Carl Icahn, who indirectly controls 77% of the common shares, heavily influences the company's business strategy and financial policies. Earlier this year, Federal-Mogul's board of directors decided to modify the company's corporate structure to create a separate and independent aftermarket division with its own CEO who reports directly to the company's board of directors. The aftermarket sector has been challenging because of fewer miles driven and low-cost competitors. Should this organizational development at Federal-Mogul either presage a strategic shift in the business mix, a transaction involving an increase in leverage, or fail to offset challenging markets, we could lower the ratings. Federal-Mogul manufactures powertrain components, sealing products, bearings, brake friction materials, and vehicle safety products for the global auto market. Its customers are original equipment (OE) manufacturers (66% of 2011 sales) and aftermarket participants (34%). We expect this mix to remain about the same. It serves light automotive vehicle (73%), heavy-duty truck (17%), and industrial (10%) markets. Aftermarket sales provide diversity to Federal-Mogul's revenue stream and have historically been more stable than OE sales. However, we believe recent experience has shown that the aftermarket is under pressure from lower consumer spending during weak economic periods, fewer miles driven, and a sharper focus on private label products. We consider Federal-Mogul's customer base and end markets as diverse. No single customer accounts for more than about 5% of sales. The company maintains a No. 1 or No. 2 market share in most of its markets, which we believe indicates acceptable technological expertise and quality. The North American market provided 38% of 2011 consolidated revenues, European markets provided 43%, and the remaining 19% of sales came from the rest of the world. Although we view commodity price fluctuations as a risk because of uncertainty of recovery from customers, the company has passed most of its incremental costs on to customers, albeit with a lag, through some contractual price escalations. In 2012, we expect higher demand in North America for light vehicles. In the U.S. light-vehicle market, we expect an increase in 2012 to 14.3 million light vehicles, and for the first time since 2008 sales are significantly greater than our estimate of scrappage rate (the upper end of estimates is 13 million units). Meanwhile, auto sales in Europe continue to decline and were down 7.1% through the first eight months of 2012 and could be down in 2013 as well. Standard & Poor's base-case outlook continues to forecast considerable regional differences in auto sales for 2012, and we believe the underlying reasons for these differences--including economic growth in China and Brazil, and fiscal uncertainty in the U.S.--could persist in 2013. We expect commercial-vehicle production in North America to rise 10% to 20% in 2012, while production is likely to decline about 10% in Europe and more than 20% in South America. Aftermarket demand has suffered from fewer miles driven, the low cost of imports, and some shift in consumer preference away from premium brands in the current economic environment. Therefore, we view this segment as more challenging than we did previously. The highly leveraged financial risk profile reflects weak credit protection measures. The company's total debt to EBITDA (adjusted to include underfunded pensions and operating leases) was 6.9x as of Sept. 30, 2012. Also, funds from operations (FFO) to total debt remained weak, at 8% as of Sept. 30, 2012. In our opinion, any improvement in EBITDA through 2013 could allow the company to decrease its leverage to about 6x before debt maturities come due starting in late 2013. In addition to refinancing risk, we assume the company could face higher interest costs following refinancing. For these reasons, we assume the company will preserve cash rather than pursue acquisitions of a material size, increase its joint-venture positions, or make large dividend payouts within the next two years. Liquidity Liquidity is "adequate" under our criteria. We believe the company has adequate sources of liquidity to cover needs in the near term, even in the event of an unforeseen EBITDA decline. We do not include the undrawn, available portion of the revolver as a source of liquidity in our analysis for 2013. Our assessment of Federal-Mogul's liquidity profile incorporates the following expectations and assumptions: -- We expect Federal-Mogul's sources of liquidity, including cash and credit facility availability, to exceed uses by 1.2x or more over the next 12 to 18 months; -- We expect net sources of liquidity to remain positive, even if EBITDA declines more than 15%; and -- In our opinion, Federal-Mogul could absorb a low-probability, high-impact market or operating shock. As of Sept. 30, 2012, Federal-Mogul had $541 million in cash and $500 million of availability under its $540 million revolver due December 2013, after accounting for $40 million in letters of credit outstanding. We do not expect the borrowing base to constrain near-term availability on the revolving credit facility. Upcoming maturities include $1.8 billion remaining on the company's term loan B due Dec. 27, 2014, and the $960 million term loan C due Dec. 27, 2015. The revolving and term loan credit facilities have no financial maintenance covenants, although some debt-incurrence covenants exist. In 2013, we expect some free cash flow from operations, after working capital and capital spending, because of Federal-Mogul's cost control measures and diverse markets. We expect negative working capital trends to reverse by next year. We expect the company to fund future capital expenditures from internal cash flow. The company has historically invested about 6%-7% of its OE sales, or 4% of consolidated sales, for capital expenditures. Federal-Mogul subsidiaries in Brazil, France, Germany, Italy, Japan, Spain, and the U.S. participate in accounts-receivable factoring and securitization facilities. Our adjusted debt figures for Federal-Mogul incorporate the amounts sold under these programs. However, the company has made a commercial decision not to factor the increase in receivables from its aftermarket customers witnessed in 2012, resulting in a use of cash this year. We would treat any factoring as debt. Recovery analysis For the complete recovery analysis, please see Standard & Poor's recovery report on Federal-Mogul, to be published following this report, on RatingsDirect. Outlook The negative outlook reflects our view that the company will probably need to refinance most of its capital structure in the next 18 months in a fragile economic environment and possibly uncertain capital markets. We could lower the rating if the company is unable to successfully address upcoming maturities during the next year and progress toward improving credit metrics is delayed. These events are likely to be related. For example, we could downgrade the company if leverage remains above 6x and we don't expect near-term improvement. This could occur if revenue is flat or negative and EBITDA margins fall below 8% in fiscal 2013. We could also lower the rating if the company's free operating cash flow fails to return to positive territory in the next couple of quarters. However, we could revise the outlook to stable if the company successfully addresses its debt maturities by refinancing in a timely manner and we believe that prospects for free cash flow are sustainable, supporting reduced leverage. Related Criteria And Research -- U.S. Economic Forecast: Long Time No See, Oct. 15, 2012 -- Credit FAQ: The Global Auto Sector Faces Obstacles And Opportunities As Regional Economic Outlooks Diverge, Sept. 18, 2012 -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; Outlook Negative To From Federal-Mogul Corp. Corporate Credit Rating B/Negative/-- B+/Stable/-- Downgraded To From Federal-Mogul Corp. Senior Secured Revolver BB- BB Recovery Rating 1 1 Senior Secured Term Loans B B+ Recovery Rating 4 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. 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