TEXT-S&P cuts TMD Friction to 'BB-'
Overview -- The credit quality of Luxembourg-based automotive supplier TMD Friction's parent, Nisshinbo Holdings, has slightly declined in our view. -- As a result, we are lowering our rating on TMD Friction to 'BB-' from 'BB' because we continue to believe that TMD's credit quality is influenced by its owner Nisshinbo. -- We nevertheless are keeping our assessment of TMD's stand-alone credit profile at 'b', despite the recent deterioration of performance and credit metrics, because we view TMD's "adequate" liquidity as a key support. -- The stable outlook reflects our expectation that TMD will continue to benefit from Nisshinbo's ownership. Rating Action On Dec 18, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Luxembourg-based automotive supplier TMD Friction Group S.A. (TMD) to 'BB-' from 'BB'. We also lowered our issue rating on TMD's EUR97 million senior secured notes outstanding to 'BB-' from 'BB'. The'3' recovery rating on the notes is unchanged, reflecting our expectation of meaningful (50%-70%) recovery prospects in the event of a payment default. Rationale The downgrade primarily relates to our view that credit quality at Nisshinbo Holdings Inc., TMD's parent, has slightly declined. The corporate credit rating on TMD continues to reflect full ownership by Nisshinbo, in line with our parent-subsidiary criteria. Although we do not rate Nisshinbo, based on public information we view its credit profile in the 'bb' category, that is, stronger than TMD's stand-alone credit profile (SACP), which we continue to assess at 'b'. We view TMD as a strategically important entity for Nisshinbo. Since the beginning of 2012, TMD has redeemed EUR63 million of its EUR160 million senior secured notes. These transactions were funded through a subordinated, noncash-paying shareholder loan from Nisshinbo. We view this as a tangible evidence of support from Nisshinbo, which now provides a meaningful portion of TMD's debt--more than one-third of nonadjusted debt. In addition, these transactions will support TMD's future cash generation by alleviating cash interests by almost EUR7 million a year. Nisshinbo is a Japanese conglomerate with activities in automobile brakes (TMD), textiles, paper products, mechatronics, chemicals, electronics, and real estate, primarily in Japan and the rest of Asia. On March 31, 2012, Nisshinbo reported annual revenues of JPY379 billion (equivalent to EUR3.4 billion as of Dec. 18, 2012). Nisshinbo is listed on the Tokyo stock exchange. We anticipate a weaker 2012 operating performance for TMD than we had previously expected under our base case. Our revised base-case scenario for 2013 assumes a further erosion of our adjusted EBITDA margin for TMD from the depressed 2012 level to slightly below 5%. We continue to see weak economic conditions in Europe, where TMD generates the bulk of its revenues. Under our revised base-case forecasts, we expect TMD to generate a ratio of funds from operations (FFO) to Standard & Poor's adjusted debt, which includes subordinated shareholder loans from Nisshinbo, barely above 5% in 2012 and 2013, which is below the 10% that we would consider commensurate with a 'b' SACP. We also anticipate Standard & Poor's adjusted debt to EBITDA will be above 6x in 2013. Despite these depressed credit metrics, we continue to assess TMD's SACP at 'b', primarily because of the company's "adequate" liquidity position. Another support to the SACP is that we expect TMD to contain negative free operating cash flow (FOCF) to limited amounts in 2012 and 2013, in part because TMD's supply chain improved, resulting in lower working-capital requirements, especially regarding inventory. Another supporting development is that TMD has reduced its vulnerability to raw material prices fluctuations, thanks to some financial hedges and new price indexation agreements with some original equipment manufacturers. However, we believe the company has consumed any headroom under the current 'b' SACP level. We could revise the SACP downward if TMD's stand-alone performance in 2013 fell below our expectations, and generated an adjusted EBITDA margin materially below 5%. Largely negative FOCF resulting in a reduced liquidity cushion would also put pressure on the SACP. Liquidity We consider TMD's liquidity position to be "adequate", as our criteria define this term. TMD's secured notes are bullet bonds that mature in 2017. The company also benefits from intercompany loans from Nisshinbo that will mature in 2018. Otherwise, the company has no significant debt maturities until 2017. TMD reported EUR33 million in cash and cash equivalents on Sept. 30, 2012. However, we treat the entire cash balance as necessary to maintain ongoing operations. Other cash sources include a EUR19 million unused committed revolving credit facility (RCF) and a borrowing base facility for a maximum amount of EUR25 million, which TMD currently used for guarantees only. We anticipate limited negative FOCF in the coming 12 months, no dividend distribution, and only very small acquisitions. However, if operating performance declines more than we expect and leads to largely negative FOCF, it could put liquidity under stress. Relevant aspects of the group's liquidity profile, based on our criteria, are as follows: -- We expect TMD's sources of liquidity over the next 12-24 months to significantly exceed uses. -- We expect that net sources would still be marginally positive if 2012 EBITDA fell 15% short of our forecast. -- TMD's secured notes are not subject to maintenance financial covenants, but only to incurrence financial covenants. The RCF includes maintenance covenants, and we expect TMD to maintain adequate headroom in our base case. However, any meaningful deterioration in operating performance from current expectations would result in tight covenant headroom. -- Our assessment of TMD's liquidity position incorporates potential shareholder support in the form of cash injections in case of liquidity need. Recovery analysis The issue rating on the EUR160 million senior secured notes (EUR97 million outstanding) issued by TMD's subsidiary, TMD Friction Finance S.A., is 'BB-', in line with the corporate credit rating on TMD. The recovery rating on the senior secured notes is '3,' indicating our expectation of meaningful (50%-70%) recovery prospects in the event of a payment default. The recovery rating on the senior secured notes is supported by a comprehensive security package comprising a first-lien security on TMD's assets (excluding accounts receivable in Germany and France) and shares shared with the RCF and the senior secured notes on a pari-passu basis in right and in priority of payment among them (as established in the intercreditor agreement), and a favorable insolvency regime, Luxembourg. At the same time, the recovery rating is constrained by some priority debt consisting of debt at the subsidiary level and part of the borrowing base facility, both of which would rank ahead of the senior secured notes in relation to some assets. The notes' documentation contains incurrence covenants restricting TMD's ability to incur additional debt subject to a fixed-charge coverage ratio of 2.25x and a senior secured leverage ratio of 3.0x, with carve-outs including an unspecified amount under receivables financing and EUR15 million under general debt basket. The documentation stipulates that additional debt must not exceed whichever is greater: EUR40 million or 65% of the amount of total accounts receivables minus EUR20 million. To calculate recoveries, Standard & Poor's simulates a hypothetical default scenario. We believe default would be triggered by declining operating performance due to prolonged weakness in demand for autos, combined with raw material price volatility. We assume that the RCF and borrowing-base facility maturing in 2014 would be refinanced on similar terms and a payment default would take place in 2015. We estimate TMD's stressed EBITDA would be about EUR30 million by the time of the hypothetical default. Our going-concern valuation envisages a stressed enterprise value of around EUR135 million, using a 4.5x stressed EBITDA multiple. After deducting priority liabilities of about EUR50 million, primarily comprising the costs associated with enforcement, debt at local subsidiaries, 50% of the outstanding pension deficit, finance leases, and part of the borrowing base facility, we calculated residual value of about EUR75 million for secured lenders. We assume around EUR122 million of secured debt outstanding at default comprising outstanding senior secured notes of EUR97 million, a fully drawn RCF of EUR19 million, and six months of prepetition interest, resulting in our expectation of meaningful (50%-70%) recovery in the event of a payment default, which according to our criteria results in a recovery rating of '3' for the senior secured noteholders. Outlook The stable outlook reflects our expectations for Nisshinbo's credit profile and the parent-subsidiary link. We expect that Nisshinbo will continue to integrate TMD operationally, therefore reinforcing the ties between the two companies and supporting the business profile. We also expect that Nisshinbo will assume any financial obligation related to the redemption or the refinancing of TMD's notes in the future. We anticipate no upside for the corporate credit rating on TMD over the next 12 months. We could lower the corporate credit rating on TMD if support and benefits from Nisshinbo's ownership declined to an extent that they would no longer offer financial support to TMD if needed. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings On Global Industrial Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- Corporate Criteria--Parent/Subsidiary Links; General Principles; Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link To Parent, Oct. 28, 2004 Ratings List Downgraded; Ratings Affirmed To From TMD Friction Group S.A. Corporate Credit Rating BB-/Stable/-- BB/Stable/-- Analytical Factors Stand-Alone Credit Profile b b TMD Friction Finance S.A. Senior Secured * BB- BB Recovery Rating 3 3 *guaranteed by TMD Friction Group S.A. 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. Use the Ratings search box located in the left column.
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