-- European original equipment market weakness and unfavorable
aftermarket trends, including lower volumes and pressure on margins, are
hurting U.S.-based auto supplier Federal-Mogul Corp.'s operating
-- We are lowering our corporate credit rating on Federal-Mogul to 'B'
-- We are also lowering our issue-level ratings on the company.
-- The negative outlook reflects looming refinancing risk because the
vast majority of the company's capital structure matures in the next three
years--the revolver in December 2013 and funded term loans in December 2014
On Oct. 25, 2012, Standard & Poor's Ratings Services lowered its corporate
credit rating on Southfield, Mich.-based Federal-Mogul to 'B' from 'B+'. The
outlook is negative.
At the same time, we lowered the issue-level ratings on the company's senior
secured revolving credit facility to 'BB-' (two notches above the 'B'
corporate credit rating) from 'BB'. The recovery rating remains '1',
indicating our expectation that lenders would receive very high (90% to 100%)
recovery in the event of a payment default. We also lowered our issue ratings
on Federal-Mogul's term loan B and term loan C to 'B' (the same as the
corporate credit rating) from 'B+'. The recovery ratings remain '4',
indicating our expectation that lenders would receive average (30% to 50%)
recovery in the event of a payment default.
The downgrade reflects the company's weaker-than-expected sales and operating
performance, partly because of European market weakness, but also industrywide
challenges in the aftermarket segment. We now view the financial risk profile
as "highly leveraged," with debt to EBITDA (adjusted to include underfunded
pensions and operating leases) approaching 7x. Additionally, free cash flow
remains negative as a result of longer accounts receivable terms with its
aftermarket customers. Even when these receivables are collected, as we
expect, long-dated receivables are now a prominent feature of aftermarket
sales to the large retailers.
The negative outlook reflects our view that the company will need to undertake
refinancing in a fragile economic environment with likely uncertain financial
market conditions in 2013. The currently unfunded revolving credit facility
expires in December 2013 and the term loans mature in December 2014 and 2015.
We think it is not likely that lenders would extend the maturity of the
revolver past the existing loan maturity.
The ratings on Federal-Mogul reflect its highly leveraged financial risk
profile and "weak" business risk profile as a major participant in the
cyclical and highly competitive global auto industry. Standard & Poor's
business risk assessment incorporates the multiple industry risks facing
automotive suppliers, including volatile demand, high fixed costs, and severe
pricing pressures. We believe intermediate-term financial prospects can
support the 'B' rating despite elevated leverage. We believe light-vehicle
production in North America should rise this year and next, although we expect
that economic activity will remain weak in Europe and Latin America in 2013.
Additionally, we expect the company will generate some positive free operating
cash flow in 2013, as the longer-dated accounts receivable terms from
Federal-Mogul's aftermarket customers is currently reaching a plateau.
We believe Federal-Mogul's controlling investor, Carl Icahn, who indirectly
controls 77% of the common shares, heavily influences the company's business
strategy and financial policies. Earlier this year, Federal-Mogul's board of
directors decided to modify the company's corporate structure to create a
separate and independent aftermarket division with its own CEO who reports
directly to the company's board of directors. The aftermarket sector has been
challenging because of fewer miles driven and low-cost competitors. Should
this organizational development at Federal-Mogul either presage a strategic
shift in the business mix, a transaction involving an increase in leverage, or
fail to offset challenging markets, we could lower the ratings.
Federal-Mogul manufactures powertrain components, sealing products, bearings,
brake friction materials, and vehicle safety products for the global auto
market. Its customers are original equipment (OE) manufacturers (66% of 2011
sales) and aftermarket participants (34%). We expect this mix to remain about
the same. It serves light automotive vehicle (73%), heavy-duty truck (17%),
and industrial (10%) markets. Aftermarket sales provide diversity to
Federal-Mogul's revenue stream and have historically been more stable than OE
sales. However, we believe recent experience has shown that the aftermarket is
under pressure from lower consumer spending during weak economic periods,
fewer miles driven, and a sharper focus on private label products.
We consider Federal-Mogul's customer base and end markets as diverse. No
single customer accounts for more than about 5% of sales. The company
maintains a No. 1 or No. 2 market share in most of its markets, which we
believe indicates acceptable technological expertise and quality. The North
American market provided 38% of 2011 consolidated revenues, European markets
provided 43%, and the remaining 19% of sales came from the rest of the world.
Although we view commodity price fluctuations as a risk because of uncertainty
of recovery from customers, the company has passed most of its incremental
costs on to customers, albeit with a lag, through some contractual price
In 2012, we expect higher demand in North America for light vehicles. In the
U.S. light-vehicle market, we expect an increase in 2012 to 14.3 million light
vehicles, and for the first time since 2008 sales are significantly greater
than our estimate of scrappage rate (the upper end of estimates is 13 million
units). Meanwhile, auto sales in Europe continue to decline and were down 7.1%
through the first eight months of 2012 and could be down in 2013 as well.
Standard & Poor's base-case outlook continues to forecast considerable
regional differences in auto sales for 2012, and we believe the underlying
reasons for these differences--including economic growth in China and Brazil,
and fiscal uncertainty in the U.S.--could persist in 2013.
We expect commercial-vehicle production in North America to rise 10% to 20% in
2012, while production is likely to decline about 10% in Europe and more than
20% in South America. Aftermarket demand has suffered from fewer miles driven,
the low cost of imports, and some shift in consumer preference away from
premium brands in the current economic environment. Therefore, we view this
segment as more challenging than we did previously.
The highly leveraged financial risk profile reflects weak credit protection
measures. The company's total debt to EBITDA (adjusted to include underfunded
pensions and operating leases) was 6.9x as of Sept. 30, 2012. Also, funds from
operations (FFO) to total debt remained weak, at 8% as of Sept. 30, 2012.
In our opinion, any improvement in EBITDA through 2013 could allow the company
to decrease its leverage to about 6x before debt maturities come due starting
in late 2013. In addition to refinancing risk, we assume the company could
face higher interest costs following refinancing. For these reasons, we assume
the company will preserve cash rather than pursue acquisitions of a material
size, increase its joint-venture positions, or make large dividend payouts
within the next two years.
Liquidity is "adequate" under our criteria. We believe the company has
adequate sources of liquidity to cover needs in the near term, even in the
event of an unforeseen EBITDA decline. We do not include the undrawn,
available portion of the revolver as a source of liquidity in our analysis for
2013. Our assessment of Federal-Mogul's liquidity profile incorporates the
following expectations and assumptions:
-- We expect Federal-Mogul's sources of liquidity, including cash and
credit facility availability, to exceed uses by 1.2x or more over the next 12
to 18 months;
-- We expect net sources of liquidity to remain positive, even if EBITDA
declines more than 15%; and
-- In our opinion, Federal-Mogul could absorb a low-probability,
high-impact market or operating shock.
As of Sept. 30, 2012, Federal-Mogul had $541 million in cash and $500 million
of availability under its $540 million revolver due December 2013, after
accounting for $40 million in letters of credit outstanding. We do not expect
the borrowing base to constrain near-term availability on the revolving credit
facility. Upcoming maturities include $1.8 billion remaining on the company's
term loan B due Dec. 27, 2014, and the $960 million term loan C due Dec. 27,
2015. The revolving and term loan credit facilities have no financial
maintenance covenants, although some debt-incurrence covenants exist.
In 2013, we expect some free cash flow from operations, after working capital
and capital spending, because of Federal-Mogul's cost control measures and
diverse markets. We expect negative working capital trends to reverse by next
year. We expect the company to fund future capital expenditures from internal
cash flow. The company has historically invested about 6%-7% of its OE sales,
or 4% of consolidated sales, for capital expenditures.
Federal-Mogul subsidiaries in Brazil, France, Germany, Italy, Japan, Spain,
and the U.S. participate in accounts-receivable factoring and securitization
facilities. Our adjusted debt figures for Federal-Mogul incorporate the
amounts sold under these programs. However, the company has made a commercial
decision not to factor the increase in receivables from its aftermarket
customers witnessed in 2012, resulting in a use of cash this year. We would
treat any factoring as debt.
For the complete recovery analysis, please see Standard & Poor's recovery
report on Federal-Mogul, to be published following this report, on
The negative outlook reflects our view that the company will probably need to
refinance most of its capital structure in the next 18 months in a fragile
economic environment and possibly uncertain capital markets.
We could lower the rating if the company is unable to successfully address
upcoming maturities during the next year and progress toward improving credit
metrics is delayed. These events are likely to be related. For example, we
could downgrade the company if leverage remains above 6x and we don't expect
near-term improvement. This could occur if revenue is flat or negative and
EBITDA margins fall below 8% in fiscal 2013. We could also lower the rating if
the company's free operating cash flow fails to return to positive territory
in the next couple of quarters.
However, we could revise the outlook to stable if the company successfully
addresses its debt maturities by refinancing in a timely manner and we believe
that prospects for free cash flow are sustainable, supporting reduced leverage.
Related Criteria And Research
-- U.S. Economic Forecast: Long Time No See, Oct. 15, 2012
-- Credit FAQ: The Global Auto Sector Faces Obstacles And Opportunities
As Regional Economic Outlooks Diverge, Sept. 18, 2012
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Downgraded; Outlook Negative
Corporate Credit Rating B/Negative/-- B+/Stable/--
Senior Secured Revolver BB- BB
Recovery Rating 1 1
Senior Secured Term Loans B B+
Recovery Rating 4 4
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