Still, we also assume private equity firm Centerbridge Partners L.P. (which acquired Dana’s interest when the company emerged from bankruptcy in early 2008) will influence Dana’s financial policy and business strategy. Centerbridge has two of the nine members on Dana’s board and elects one member that is independent. The capital structure includes $753 million in 4% cash-pay convertible preferred stock held by Centerbridge and certain previous creditors, which we view as equity.
Dana’s lease- and pension-adjusted total debt to EBITDA was 2.0x as of Sept. 30, 2012. We expect Dana can keep leverage below or at 2.5x, even as it expands its global presence for automotive driveline products and power technologies and increases its aftermarket business. We assume EBITDA expansion will be sufficient to offset any growth-related incremental debt we believe it might incur in 2013. In addition, we believe funding for small acquisitions and investments will not drive free operating cash flow into negative territory. Discretionary free cash flow totaled $270 million (per our calculation) for the 12 months ended Sept. 30, 2012, before a voluntary $150 million pension contribution. Funds from operations (FFO) to total debt rose to 36% as of Sept. 30 (excluding the $150 million voluntary pension contribution), and we expect it to remain above 30% for the significant financial risk profile score.
Dana manufactures driveline products including axles, driveshafts, transmissions, and power technologies, including sealing and thermal products. Dana’s customers are original equipment manufacturers (OEMs) of vehicles in the light-vehicle, heavy-duty commercial, and heavy off-road markets. The company began to expand its aftermarket business in 2012, which should, over the long term, increase the diversity and counter-cyclicality of its revenue stream.
The business profile is “weak,” reflecting Dana’s exposure to the cyclical and highly competitive light and heavy duty vehicle markets. For example (excluding foreign exchange), organic revenue in the third quarter decreased 5% compared with 2011 because of production volumes, pricing, and product mix.
Results in the regions were mixed according to variations in light and heavy vehicle production and new product launches--sales were up in Europe and Asia Pacific and down in North and South America. We assume these types of regional differences will continue.
We estimate lease- and pension-adjusted EBITDA can reach $850 million in 2012. The company’s lowered guidance for 2012 adjusted EBITDA is $780 million to $800 million. Dana’s trailing-12-month adjusted EBITDA margin rose to 11.2% as of Sept. 30, 2012, up from 10.3% as of Sept. 30, 2011. We believe Dana can achieve EBITDA margins near 11% in 2012 and 2013 because of expected volume growth in selected global markets and cost side efficiencies. By segment, EBITDA margins for the first nine months of 2012 were 13.7% for power technologies, 12.9% off highway, 9.8% light vehicle driveline, and 10.6% commercial vehicle.
Dana’s OE end markets are fairly diverse relative to the rated auto supply sector. For 2011, light vehicles made up about 42% of sales, medium- and heavy-duty commercial vehicles 38%, and off-road vehicles (construction, mining, and agriculture) 20%. Although Dana’s customer mix is somewhat diverse--the Michigan-based OEMs account for less than 25% of Dana’s sales--its axle and driveshaft businesses depend materially on Ford Motor Co., which accounts for 15% of global sales. Dana’s geographic diversity is good, reflecting the distribution of its OEM customers. For the nine months ended Sept. 30, 2012, North America accounted for 44% of Dana’s revenues, Europe 25%, South America 11%, and Asia 20%. Still, in the event of another global downturn, we believe this diversity would be of limited benefit to any auto supplier, as in 2008-2009.
We assume Dana’s organic revenue will be positive in 2013 because of our expectations for modest growth in North American auto production, possibly flat 2013 North American commercial-truck demand, and potential improvement in the Brazilian truck market. We expect light-vehicle production in Europe to decline about 5%, and commercial vehicle production to be flat or down somewhat. In the North American light-vehicle market, we expect 2013 sales to increase 6% to 15.3 million units from 14.4 million units sold in 2012 (13.4% increase over 2011). In the North American light-vehicle market, we view Dana’s significant exposure to light trucks and SUVs, relative to passenger cars, as a potential risk if gasoline prices rise closer to $5 per gallon and consumers purchase smaller vehicles cars in response.
We expect the competitive landscape to remain highly competitive, but largely unchanged for Dana in 2013. As with virtually all Tier 1 auto suppliers, Dana faces competition from formidable peers as well as the internal production of a few OEMs. Also, all Tier 1 light-vehicle suppliers are exposed to their own suppliers, and we believe many smaller suppliers remain in fragile financial health and depend on their customers for periodic financial assistance in the recession.
We believe an additional long-term risk for Dana is any unrecouped increases in commodity costs--primarily for steel and aluminum, the costs of which remain volatile. We believe Dana addresses this exposure through customer purchase programs, price increases, and negotiated contracts that allow for a lag in recovering the cost of materials. Dana has indicated that 75% of its incremental steel costs are recoverable through contracts.
Dana invests heavily in markets that it expects will have good future growth, as are many of its competitors. In our view, slower-than-expected demand near term in these markets remains a risk, given the large increases in capacity many suppliers are making in these regions. In China, Dana has a 50% its stake in Dongfeng Dana Axle Co., a commercial vehicle axle joint venture (JV) and the sole supplier of medium and heavy truck axles to Dongfeng Motor Co. Ltd., which is the largest commercial truck manufacturer in China. In South America, Dana has an agreement with SIFCO SA for the distribution rights to SIFCO’s commercial vehicle steer axle systems and an exclusive long-term supply agreement for certain driveline components.
Liquidity is “adequate” under our criteria. Our assessment of Dana’s liquidity profile incorporates the following expectations and assumptions:
-- We expect sources of liquidity, including cash and facility availability, to exceed uses by 1.2x or more over the next 12-18 months.
-- We expect net sources to remain positive, even if EBITDA declines as much as 15%.
-- Compliance with financial covenants could survive a 15% drop in EBITDA, in our view.
-- Because of Dana’s diverse revenue stream and good operating efficiency, we believe it could absorb low-probability, high impact events.
Dana reported an unrestricted global cash balance of $818 million as of Sept. 30, 2012, of which $202 million was held in the U.S. We assume the company will retain about $600 million of this cash to run the business and reserve the remainder for acquisitions and investments in the next few years to expand its global presence. We estimate Dana can generate free cash from operations (before one-time pension contributions) of about $200 million for 2012 and $300 million for 2013 because of lower capital spending and earnings expansion.
Dana is restructuring for operating efficiency to offset pricing pressures and volatile commodity costs. The company has stated that it expects restructuring expense for 2012 to be about $60 million.
We believe Dana’s unfunded pension and other postretirement employee benefits obligations--which totaled $771 million at year end 2011--are manageable because of the company’s free cash generation and its reduced leverage. During January 2012, Dana made a voluntary $150 million contribution to its U.S. pension plans in excess of the expected minimum required contributions for 2012 (which was reported to be $70 million in 2012). Dana states that it expects U.S. plan to be fully funded by 2019.
Dana has no near-term debt maturities. Its $400 million 6.5% senior notes mature in 2019, and its $350 million 6.75% senior notes mature in 2021.
Dana has a $500 million asset-based loan (ABL) revolver that expires February 2016. As of Sept. 30, 2012, the undrawn revolver had availability, based on the company’s borrowing base collateral, of $327 million after taking into account $66 million for letters of credit. At Sept. 30, 2012, the company was in compliance with the debt covenants under its revolver.
Separately, Dana has a EUR75 million ($96 million) receivables securitization program that matures in 2016. As of Sept. 30, 2012, there was $91 million of availability, but no borrowings, under the European trade receivable securitization program based on the effective borrowing base. We believe Dana also has a $51 million debt obligation in Brazil, expiring in the fourth quarter of 2015 that we expect to be rolled over at maturity to support its Brazilian operations.
The company’s capital spending estimate for 2012 has been reduced sharply to about $160 million (from $230 million) because of lower sales. We expect capital spending to remain relatively conservative until revenues stabilize. Dana also has cash dividend payments of about $31 million annually on its $762 million of 4% preferred stock, and the company initiated a small dividend on common shares early in 2012 that will total about $30 million for the initial year.
Dana has board authorization to repurchase up to $250 million of its common shares, as of Oct. 25, 2012.
The rating on Dana’s senior secured revolving credit facility is ‘BBB-', two notches above the corporate credit rating. The recovery rating is ‘1’, indicating our expectation that lenders would receive very high (90% to 100%) recovery in a default scenario. The rating on Dana’s unsecured debt is ‘BB’, the same as the corporate credit rating, and the recovery rating on this debt is ‘3’, indicating our expectation that lenders would receive substantial (50% to 70%) recovery in a default scenario. (For the complete recovery analysis, please see the recovery report on Dana Holding Corp., published March 6, 2012, on RatingsDirect.)
Our stable rating outlook on Dana reflects our view that its focus on maintaining operating efficiencies will enable it to increase earnings and generate free cash flow for 2012 and 2013 from continued modest growth in global markets. Aside from internal growth, we expect the company to pursue midsize acquisitions while maintaining the credit measures we believe are appropriate for the rating. For the rating, we expect Dana to maintain lease- and pension-adjusted total debt to EBITDA of 2.5x or lower and FFO to total debt of at least 30%. We expect the company will continue to generate positive discretionary free cash flow, and we anticipate no material change in the business strategy or financial policy.
We could raise our ratings if we believe Dana can sustain increased EBITDA such that adjusted leverage falls to 2.0x or lower and FFO to total debt approaches 40% or better over a sustained period. An upgrade would also take into account the sustainability of credit metrics at or above recent levels. For example, we calculate that Dana’s adjusted leverage would decline to a level comfortably below 2.0x (where it was as of Sept. 30) if its revenues expand in 2013 and it can achieve gross margin (excluding depreciation) of 15.5% or better. We would also need to believe that any use of its sizable cash balances would be consistent with our expectations for a higher rating, indicating that Dana is maintaining a financial policy consistent with that during the recent post-bankruptcy period.
We could lower our ratings if we believe auto industry markets will not improve as we have assumed, or if the economic recovery falters, preventing Dana from achieving the financial assumptions that we expect for the rating in 2013. Leverage could rise to 2.5x or higher if revenue falls 5% or more and gross margin declines 200 basis points from the 2011 level. We also could lower the ratings if free cash generated after capital spending drops below $100 million for any rolling 12-month period, or if Dana pursues a material debt-financed acquisition or large dividend payouts.
Related Criteria And Research
-- U.S. Auto Sales Poised To Continue Recovery In 2013; 2012 Sales In Line With Standard & Poor’s Expectations, Jan. 4, 2013
-- Top 10 Investor Questions For 2013: Global Autos And Trucks, Dec. 5, 2012
-- Issuer Ranking: Global Auto Suppliers, Strongest To Weakest, Oct. 10, 2012
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Key Credit Factors: Business And Financial Risks In The Auto Component Suppliers Industry, Jan. 28, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Temporary telephone contact numbers: Nancy C. Messer, CFA (917-623-4910); Robert Schulz (347-782-3780).