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May 9 (The following statement was released by the rating agency)
Fitch Ratings has revised Swiss-based STMicroelectronics NV's (ST) Outlook to Stable from Negative and affirmed its Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB-'.
The revision of the Outlook to Stable reflects Fitch's view that ST's earnings and cash flow profile is more visible, following the dissolution and winding down of the wireless business, successful cost base restructuring and an improving revenue trend.
ST's ratings are supported by a strong industry position and leadership across a range of product categories, which are however offset by a portfolio mix where a number of business segments are expected to continue to generate materially negative margins and where target margins are unlikely to be achieved unless these businesses start generating strong revenue trends.
ST exited the ill-fated ST-Ericsson (STE) wireless JV with Ericsson in 2013, a JV that contributed very material losses and negative cash flows since inception. Restructuring that has reduced the cost base to previously announced targets and growth expectations for 2014 and 2015 underpin Fitch's expectations of EBIT margin expansion from current low-single digit levels, and positive, albeit low levels of post dividend free cash flow. Conservative financial policies including consistent levels of gross and net cash provide further support.
The ratings are presently constrained by challenges in returning the Embedded Processing Solutions division to positive earnings and consolidated results to management's targets on a sustainable basis.
KEY RATING DRIVERS
Margin and Cash Flow Profile
Impairment, restructuring and capacity underutilisation charges, have all contributed to weak margin performance over the past two years. Fitch estimates that underlying EBIT margin (excluding wireless) has been in the 2%-3% range. Cash flow has similarly been impacted by the substantial cash flow losses generated by the wireless business. Fitch expects EBIT margin and cash flow to improve through 2014 and 2015, although we remain cautious over management's ambition to reach a 10% EBIT margin by mid-2015 given the revenue expansion needed to reach this target.
Cost Base Visibility
Volatility in ST's top-line has been pronounced in recent years due mainly, but not uniquely, to the wireless business. Organic revenues nonetheless performed better than ST's addressable market in 2013 and management met its targeted cost base restructuring - quarterly net operating expenses (R&D, SG&A and R&D grants) between USD600m and USD650m - one quarter ahead of plan. While poorly performing product categories have taken time to exit, cost base restructuring has been good and Fitch's rating case assumes that operating expenses will be managed within its targeted range.
Well Defined Financial Model
Management expects a 10% EBIT margin by mid-2015 based on a target of run-rate revenues reaching USD9bn, quarterly opex as stated, and a gross margin of 36%-38%. Revenue trends - growth and mix - will be key to improving the gross margin. R&D grants of around USD30m per quarter are due to start in 2Q14, along with opex visibility, should support margin expansion through 2014 and beyond. Revenue visibility - both at the industry and company level - is less certain. Fitch's rating case assumes lower revenue trends than targeted, but that a mid-single digit EBIT margin is achievable and supportive of a 'BBB-' rating.
Conservative Financial Profile
Despite Fitch's estimate of cash flow losses exceeding USD3bn generated by STE over the past three to four years (losses that have been borne equally by Ericsson) ST has managed its balance sheet conservatively. The company has consistently reported a net cash position, its liquidity is considered strong and its funding requirements are modest. Financial metrics are supportive of the ratings with the company reporting no net financial leverage (on a lease adjusted basis) and fixed charge cover approaching 5x in 2013; a metric that is expected to rise materially in 2014. While underlying operating trends are more influential ratings drivers, a cautious approach to capital structure has helped mitigate a period of significant portfolio challenges and revenue volatility.
Positive: Future developments that could lead to positive rating actions include:
-Consolidated operating margins trending consistently in the mid-single digit range
-Low-single digit free cash flow margin (post-dividend cash flow to sales)
Negative: Future developments that could lead to negative rating action include:
-Failure to generate anything more than zero to low-single digit operating margins on a consolidated basis
-Failure to generate positive free cash flow on a sustainable basis, which would likely lead to a downgrade in the absence of management action (ie. capex and or dividend cuts)
-Financial policies leading to a reversal of net cash position