TEXT - S&P raises Lear Corp to 'BB+'
Overview -- Amid weakening demand in Europe in 2012, Lear Corp.'s margins have been fairly steady partly because of beneficial customer mix, and we expect the company to generate a solid level of free operating cash in 2012 and 2013. -- Lear Corp. plans to issue senior unsecured debt of $500 million maturing in 2023 and increase the size of its revolver to $1 billion from $500 million and extend its maturity from 2016 to 2018. -- We are raising the corporate credit rating to 'BB+' from 'BB' and assigning a 'BB' issue rating to the senior unsecured notes and a 'BBB' issue rating to the company's senior secured revolving credit facility. -- The outlook is stable, partly reflecting our assumption Lear will generate at least $250 million in annual free cash flow in 2013 and maintain a ratio of free operating cash flow to debt of more than 10%. Rating Action On Jan. 14, 2013, Standard & Poor's Ratings Services raised the corporate credit rating on Southfield, Mich.-based Lear Corp. to 'BB+' from 'BB'. The outlook is stable. At the same time, we assigned a 'BBB' rating and '1' recovery rating to the senior secured revolving credit facility, indicating our expectation of very high (90% to 100%) recovery for debtholders in the event of a payment default. In addition, we assigned a 'BB' issue-level and '5' recovery rating to the company's $500 million senior unsecured notes maturing in 2023, indicating our expectation of a modest (10% to 30%) recovery for debtholders in the event of a payment default. The issue-level rating remains 'BB' on the company's 7.875% senior unsecured debt maturing in 2018 and the 8.125% million senior unsecured debt maturing in 2020, but we are revising the recovery ratings to '5' from '3'. We revised the recovery rating lower to reflect the increase in secured debt potential under the revolver. Rationale The ratings on Southfield, Mich.-based automotive systems supplier Lear Corp. reflect Standard & Poor's opinion of the company's "intermediate" financial risk profile and "weak" business risk profile, which are unchanged. Amid weakening demand in Europe in 2012, margins have been fairly steady. Moreover, we expect the company to generate a solid level of free operating cash in 2012 and 2013. We assume Lear's 2013 global sales will be at least $14.7 billion. We also expect light-vehicle production to increase about 3% year over year in North America and to fall about 4% year over year in Western Europe. For the current rating, we assume the company's debt to EBITDA will remain less than 2x and that free cash flow will be more than $250 million in 2013. We adjust reported debt to add the present value of operating leases and underfunded postretirement benefit obligations. We consider Lear's business risk profile weak largely because of volatile auto production, high fixed costs, fierce competition, and pricing pressures that constrain margins. Furthermore, Lear has significant customer concentration--38% of 2011 sales were to General Motors Co. (GM; BB+/Stable/--) and Ford Motor Co. (BB+/Positive/--). Moreover, we believe Lear still has significant exposure to pickup trucks and SUVs in North America, for which demand could fall if the price of gas again rises significantly and eventually nears $5 per gallon. The company competes in the highly competitive and cyclical global auto supplier market and has single-digit EBITDA margins. Its solid financial credit measures continue to improve because of an ongoing increase in light-vehicle demand in North America and strong growth in emerging markets. We believe the company's profitability and cash flow are sustainable, even if sales weaken, because of cost reductions and a low debt burden, even with the issuance of $500 million senior unsecured debt. We expect the industry to remain volatile, and this volatility, along with unpredictable raw material costs, can cause large swings in cash generation and use. Still, we assume Lear will retain a substantial portion of its large cash balances over time and that debt will remain at about the current level. The Tier 1 auto supplier is made up of two divisions: seating systems, which designs and manufactures complete seats and components for the passenger-car and light-truck markets, and electrical power management systems, which designs and manufactures wire harnesses, terminals and connectors, junction boxes, body control electronics, wireless products, and premium audio systems. Seating has lower margins than electronics. In the seating systems division, Lear's revenue from GM represents a concentration risk, in our view. We expect Lear to remain the No. 2 player in the global seating systems market. Business in China is expanding, and Lear's consolidated sales backlog for 2013 through 2015 currently totals $1.8 billion. The company has benefitted, in our view, from years of various restructuring actions, such as transferring manufacturing capacity to lower-cost regions, reducing manufacturing capacity, and eliminating administrative overhead. The company has pursued what it calls a low-cost-country strategy designed to increase its global manufacturing and engineering competitiveness. The company has expanded vertical integration in Mexico, Eastern Europe, Africa, and Asia. It has also increased low-cost engineering capabilities in China, India, and the Philippines. These actions have helped its electrical power management systems division support global platforms and increase scale, bolstering profitability. We assume the company will generate substantial positive free operating cash flow (FOCF) at about $275 million in 2012 and at least approximately that amount in 2013. Liquidity We believe Lear continues to have "strong" sources of liquidity to cover its needs in the near term, even in the event of unforeseen EBITDA declines. Our assessment of Lear's liquidity incorporates the following expectations and assumptions: -- We expect Lear's sources of liquidity, including cash and facility availability, to exceed uses by 1.5x over the next 12 months. -- We expect net sources to remain positive, even if EBITDA declines more than 30%. -- Because of Lear's good conversion of EBITDA to discretionary cash flow, we believe it could absorb low-probability, high-impact shocks. Liquidity sources include cash and equivalents as of Sept. 29, 2012, of $1.3 billion and, we assume, a revolver that will soon be $1 billion. Financial covenants govern the new revolving credit facility. We expect a comfortable cushion under the existing financial covenants in 2013. Also, Lear has two senior unsecured notes outstanding: $315 million in 7.875% notes due 2018 and $315 million in 8.125% notes due 2020. The new senior unsecured debt of $500 million maturing in 2023 will largely bolster cash balances. We expect the company to generate a significant amount of positive free cash flow in 2013, but its cash flows are highly sensitive to future vehicle production and to the mix of vehicle types, in our view. Lear's cash needs are in the U.S., where the bulk of its debt resides. Because most of its operating income comes from its foreign subsidiaries, Lear depends on them for dividends, intercompany loan repayments, royalties, and other distributions to satisfy its obligations. We believe no material restrictions exist on its subsidiaries making such distributions to Lear. The company will spend cash on share buybacks. Lear's board of directors has increased its existing share repurchase program to $1.5 billion and extended the authorization until Jan. 10, 2016. As of Dec. 31, 2012, the company has repurchased $502 million of its shares and, therefore, the new repurchase program provides for repurchases of about $1 billion over three years. In 2012, we expect dividends to be about $50 million, well within the company's cash flow. We expect capital expenditures of about 3% of sales in 2012 and 2013. Recovery analysis Please see Standard & Poor's upcoming recovery report on Lear, to be published after this report on RatingsDirect. Outlook The outlook is stable. We assume that Lear will generate at least $250 million in annual free cash flow in 2013, maintaining a ratio of free operating cash flow to debt of more than 10%. In addition, we assume adjusted debt to EBITDA will remain less than 2x, and cash balances will remain substantial. This implies gross margins above 7% and flat to positive sales growth. We could lower the rating if the company increased its leverage substantially or used cash to fund a large acquisition or pay a special dividend. We could also lower the rating if global vehicle demand declines again, the company uses cash, or leverage exceeds 2x on a sustained basis, which we estimate could occur if 2013 revenue declined versus 2012 levels and gross margins fell below 6%. To raise the rating to investment grade, we would need to be convinced that the company's business model would be comfortably resilient in the face of industry downturns over the long term as well as improving profitability. This means that we would need to reassess the business risk profile to at least "fair." We would expect adjusted EBITDA margins in both its seating and electrical power management businesses to expand toward the double-digits on a sustained basis. The current financial profile (if sustained) is already consistent with a higher rating, as we consider it "intermediate." Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Key Credit Factors: Business And Financial Risks In The Auto Component Suppliers Industry, Jan. 28, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded To From Lear Corp. Corporate Credit Rating BB+/Stable/-- BB/Stable/-- New Rating Lear Corp. Senior secured $1 bil. revolver due 2018 BBB Recovery Rating 1 Senior unsecured $500 mil notes due 2013 BB Recovery Rating 5 Ratings Affirmed; Recovery Rating Revised To From Lear Corp. Senior Unsecured BB BB Recovery Rating 5 3