-- We have revised the business risk profile on Harman International
Industries Inc. to satisfactory from fair because we believe the company will
be able to retain its competitive position, especially in the automotive audio
and infotainment segments.
-- We assume the company will maintain or improve margins in most
segments and that management will pursue a conservative financial policy.
-- We have raised the corporate credit rating on Stamford, Conn.-based
auto supplier Harman International Industries Inc. to 'BBB-' from 'BB+'.
-- The stable outlook reflects our view that the company's improved
operating performance will enable it to remain profitable and cash flow
positive despite weak demand in Europe.
On Sept. 6, 2012, Standard & Poor's Ratings Services raised its corporate
credit rating on Harman International Industries Inc. to 'BBB-' from 'BB+'.
The outlook is stable. At the same time, we also raised our rating on the
senior unsecured debt to 'BB+' from 'BB'.
The upgrade reflects our revision of Harman's business risk profile to
"satisfactory" from "fair," based on our assumption that the company will be
able to sustain profitability at or above double-digit EBITDA margins, expand
its global manufacturing presence along with the automakers it supplies, and
continue to successfully innovate its software- and hardware-based product
lines. We believe this is feasible, given the track record of recent years and
our expectation of mixed but overall slow recovery in auto sales and vehicle
production globally. We assume growth in the emerging markets will exceed that
for most mature markets in the year ahead. We expect new-vehicle demand to
improve in North America at about 11% year over year in 2012, but sales will
likely fall in Europe for the fifth year in a row in 2012.
We believe Harman's products, which are largely software based, can withstand
the risk of commoditization, as well as potential inroads from other
competitors that may have greater financial resources. In our opinion, the
company has the technological capabilities to continue a leadership position
in innovating product for the connectivity-infotainment segment of the auto
industry, where vehicle performance safety and satisfaction of consumer's
desire for information intersect. Harman's recently developed scalable
infotainment products have the potential to expand its vehicle exposure beyond
premium brands to more price sensitive volume brands.
The ratings also reflect Harman's "intermediate" financial profile, including
our expectation that the company can generate positive free cash flow after
capital spending of at least $150 million per year in the next two years,
lease-adjusted leverage will remain below 2.5x (it was 1.4x for fiscal year
end June 30, 2012), and funds from operations (FFO) to total debt will remain
above 30% (it was 65.4% as of June 30). We believe that, given the company's
sizable backlog of new automotive business to be launched in the next several
years, the company will be able to generate double-digit margins and free cash
flow next year despite significant economic uncertainty. Less profitable auto
business has been running off and should be minimal by 2016 at worst.
Through its multiyear restructuring program and relocation to low-cost
countries, Harman, in our opinion, has achieved an operational break-even
point that better fits expected intermediate-term global auto production
levels. Also, the company continues to win new business awards from major
global automakers that should boost revenues beginning in 2013, when this new
business is scheduled to launch. The automotive order backlog totaled $16.1
billion at fiscal year-end June 30, 2012. New auto order in fiscal 2012
totaled $4 billion for infotainment and $1.2 billion for branded car audio. We
believe the company's profit potential and competitive standing in its markets
depend on operational efficiencies and ongoing technological innovation, which
is why the company targets research and development (R&D) spending at 8% of
We believe that management's financial policies will remain conservative.
Still, we expect the company will pursue periodic acquisitions of technology,
although most should not lead to higher leverage, depending on the size of the
investment. Also, the board has recently authorized a $200 million share
repurchase authorization and initiated dividend payments to shareholders. We
believe the company's free cash flow will support these shareholder friendly
actions rather than debt.
The upgrade incorporates the assumption that the company will be able to
comfortably manage its $400 million October 2012 debt maturity with cash on
hand or alternative borrowing. Kohlberg Kravis Roberts & Co. L.P. (KKR; not
rated), holds Harman's $400 million 1.25% convertible notes and controls one
seat on Harman's board of directors. We do not expect KKR to make a renewed
leveraged buyout attempt, given a standstill agreement, and we have no reason
to believe KKR's presence in the corporate capital and governance structures
has hurt Harman's financial and business strategies. In addition to KKR, an
activist shareholder--Relational Investors LLC (not rated; Ralph Whitworth and
David Batchelder)--has held shares in Harman since 2009. We acknowledge the
potential for more aggressive shareholder friendly actions typically
associated with such investors. But our rating on Harman incorporates the
assumption that it will remain an independent, publicly traded company with a
conservative financial policy based upon the track record developed under
current management and while Relational has been a shareholder.
The company reports three business segments:
-- Infotainment, which provides 56% of sales and EBITDA margin of 10.2%
in fiscal 2012;
-- Lifestyle (auto and consumer audio products), with 30% of revenues and
13.1% EBITDA margin; and
-- Professional audio, with 14% of revenues and 16.7% EBITDA margin.
Harman's satisfactory automotive business position benefits from its expertise
in audio technology, which is evident from its strong position in the
professional audio market, and from brand awareness garnered in the consumer
audio market. The company has well-recognized brand names in audio products,
such as Harman/Kardon, JBL, and Infinity, and a leading market position in
branded automotive audio products, as well as in general audio equipment for
Harman's business risk profile reflects its material exposure to the highly
competitive global auto market--which accounts for about 70% of the company's
revenues--and concentration of sales with certain automakers. Harman holds a
significant position (a reported 22% market share) in infotainment technology
for the auto market. Harman has fair geographic diversity with its $4.4
billion of fiscal 2012 revenues derived 30% in Europe (74% from Germany, and
the remainder from U.K., France, Italy, and Spain), 40% in North America, 12%
in the BRIC countries (Brazil, Russia, India, and China), and 18% in the rest
of the world. Harman's auto products are concentrated among premium branded
vehicles--BMW AG constituted 19% of automotive sales in fiscal 2012,
Audi/Volkswagen AG 14%, followed by Toyota, Fiat Chrysler, and Daimler AG.
We consider Harman's liquidity as "strong" under our criteria. We believe
Harman can more than cover its needs for the next two years, even if EBITDA
were to decline 30% from our assumed level.
As of June 30, 2012, the company had $617 million in cash and $203 million in
short-term investments. Also, the company had $541.3 million of available
borrowing capacity, net of letters of credit, on its undrawn $550 million
multicurrency revolving credit facility that expires in December 2015.
Under the revolving facility, covenants include the requirement that the
interest coverage ratio must be more than 3.25 to 1.00, total leverage must be
less than 4.00 to 1.00, and senior leverage must be less than 3.00 to 1.00 at
the end of each quarter, on a trailing-12-month basis. The covenants do not
tighten over time. We believe that Harman will have adequate EBITDA cushion in
meeting these requirements.
Harman's only debt maturity is its $400 million, 1.25% convertible note issue
due October 2012. We believe the company will fund payment of this obligation
when it's due with available cash, but a refinancing of this maturity would
not affect the rating since leverage is currently well under 2x.
The company generated $156 million in free cash flow for the fiscal year-end
2012, and we believe it will generate free cash flow, after capital spending,
in fiscal 2013 and 2014 of at least $200 million, given reduced cash
restructuring costs versus prior years. But potentially higher working capital
requirements for product launches could offset this.
During fiscal 2013 and 2014, we expect the company to use cash for midsize
acquisitions, share repurchases, and dividend payments. In October 2011, the
board authorized share buybacks up to $200 million and a modest dividend was
reinstated in fiscal 2011. The company repurchased $124 million of its common
stock in fiscal 2012.
We expect capital spending to remain at about 3% or less of revenues in fiscal
2013 and 2014, and R&D expenditures to average 8% of revenues in the future.
Harman's unfunded pension obligation is not significant.
Our stable rating outlook on Harman reflects our view that its improved
operating performance, resulting from attention to cost, efficiency, and
engineering initiatives, and currently strong financial metrics will enable it
to remain profitable and cash flow positive despite weak demand in Europe in
the year ahead. The company occupies a growth segment within the auto
market-driver-oriented electronic information devices that are safely
interconnected with vehicle operations. Our base case assumes that the company
will remain committed to balancing investments, dividends, and acquisitions in
line with an investment-grade financial profile. At the current rating, we
believe the company has sufficient free cash flow to accommodate some
acquisitions and modest share buybacks.
We could raise the rating in the next two years if Harman continues to win
business with good margins, demonstrates its ability to innovate to maintain
its leadership position in Western markets for auto audio and infotainment,
further diversifies its customer base, and generates EBITDA margins that
remain in the top quartile of the auto supplier sector. For an upgrade, we
would also expect the company's credit metrics and cash flow after capital
spending to remain somewhat improved from those reported as of June 30, 2012.
This will be challenging because of the company's exposure to cyclical and
highly competitive end-markets with potential swings in profitability and our
view that there will be some expansion through acquisitions that may add some
debt from time to time. Over the longer term, it is less likely that the
business profile could improve, given our view that the auto industry is
evolving into a global marketplace and, as a result, competition and
cyclicality will continue to be a major consideration in the years ahead.
We could lower our ratings if we see an increased likelihood of a combination
of adverse market conditions, large acquisitions, or share buybacks that would
weaken the company's credit measures to below what we see as commensurate for
the 'BBB-' rating. We could lower the ratings if free operating cash flow
turns negative for multiple quarters, or if FFO to total debt were to decline
below 30%. We believe this would not occur unless another very substantial
downturn in auto production caused Harman's revenues to decline 25% or more.
Related Criteria And Research
-- August U.S. Auto Sales Rise Above Standard & Poor's 2012 Full-Year
Expectation, Sept. 5, 2012
-- Issuer Ranking: Global Auto Suppliers, Strongest To Weakest, June 8,
-- The Credit Overhang: Implications For The Global Automotive Sector Of
A Hard Landing In China, May 29, 2012
-- Credit FAQ: Top 10 Investor Questions: What Are The Issues To Consider
In Credit Analysis Of The U.S. Auto Sector In 2012?, May 15, 2012
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,
May 27, 2009
-- Key Credit Factors: Business And Financial Risks In The Auto Component
Suppliers Industry, Jan. 28, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Upgraded; Outlook Action
Harman International Industries Inc.
Corporate Credit Rating BBB-/Stable/-- BB+/Positive/--
Harman International Industries Inc.
Senior Unsecured BB+ BB
Recovery Rating NR 5
Complete ratings information is available to subscribers of RatingsDirect on
the Global Credit Portal at www.globalcreditportal.com. All ratings affected
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