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-- Class 8 truck orders have weakened, causing original equipment manufacturers to reduce their build schedules during the third and fourth quarters, and volumes are down significantly in the second half of the year compared with the first half.
-- The loss of standard position at both Paccar and Navistar and continued offshore pressure have hurt Accuride Corp.'s Gunite unit revenue projections.
-- We are lowering our corporate credit rating on Accuride Corp. to a 'B-' from a 'B'.
-- The outlook is negative, reflecting several factors, including weakening truck demand, ongoing challenges fixing the Gunite and Imperial businesses, and decreased liquidity.
On Dec. 19, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Evansville, Ind.-based commercial-vehicle component supplier Accuride Corp. to 'B-' from 'B'. The outlook is negative. We have also lowered the issue-level rating on the company's senior secured notes to 'B-' from 'B'. The recovery rating remains '4', indicating our expectation for average (30% to 50%) recovery in the event of a payment default.
The ratings on Accuride reflect Standard & Poor's view that the company has a "highly leveraged" financial risk profile and a "vulnerable" business risk profile, according to our criteria. We think the company continues to make some progress in its turnaround. But Class 8 truck orders have been weak, causing original equipment manufacturers (OEMs) to reduce their build schedules during the third and fourth quarters. Volumes are down significantly in the second half of the year compared with the first half. The loss of standard position at both Paccar and Navistar and the continued offshore pressure at Gunite and in the aftermarket steel wheels business has hurt the company's revenue projections. Also, we think Navistar, a large customer of Accuride, has suffered market share losses.
The Brillion unit's monthly order backlog had fallen in September by about 40%, compared with the average of the July and August orders. While the business is still profitable, the falloff has reduced sales and profit expectations for the rest of the year. Returning the Imperial business to profitability continues to be a challenge. The company is negotiating with customers for higher prices or else it may exit those contracts.
Credit metrics continue to deteriorate. We expect leverage to be 6.5x at the end of 2012 and 6x at the end of 2013. Moreover, by the end of the 2012, we expect liquidity to be about $60 million. Under our base assumptions, Accuride will probably have breakeven free cash flow in 2013. However, given that soft demand will likely extend into 2013, there is significant uncertainty surrounding our base case. In the first quarter, liquidity could dip below $50 million.
At the same time, the company has strengthened its Wheels business and continues to make progress fixing its Gunite business. For instance, the company has consolidated its heavy-duty wheel production at its Henderson and Monterrey facilities and is now profitable at its London, Ontario, facility because of better agreements with customers and the Canadian Auto Workers union. Also, aluminum wheel capacity has doubled since 2011 and should enable the company to supply customer needs in this growing segment.
In addition, the company has been implementing LEAN systems to improve operational and financial efficiencies and is reducing head count by 14% to adjust to current demand trends. At its Gunite business, the company has completed 90% of its operational stabilization plan and 85% of its machining and assembly investment. Management is consolidating the Elkhart and Brillion machining facilities into the Rockford facility and is expected to close at the end of the first quarter of 2013. Management believes that, based on operational improvements in manufacturing, distribution and supply chain, the company can increase EBITDA margins by 10% to 12%. Accuride has good market share, because it is North America's largest manufacturer of heavy steel wheels and other commercial-truck components. Still, its markets are extremely cyclical, and its high fixed-cost base and capital intensity can lead to large fluctuations in profitability. Geographic diversity, though, is minimal. The U.S. market accounts for more than 90% of Accuride's total revenues, and Canada and Mexico account for nearly all the remainder. The company plans to expand internationally, which we expect to be a multiyear process.
The customer base is highly concentrated. The top four customers accounted for about 54% of 2011 revenues, although Accuride has longstanding relationships with each of these customers. We believe any unrecouped increases in commodity costs, primarily for steel and aluminum (the costs for which remain volatile) are a further risk. Accuride has agreements with customers that allow it to pass on higher costs, but these often have a lag period and can absorb liquidity until recovered.
We expect commercial-vehicle production in North America to be flat or slightly negative in 2013. Truck freight tonnage, a key indicator for truck demand overall, but particularly for heavy-duty Class 8 trucks, rose 3.7% sequentially in November after falling 3.7% in October 2012. Year over year, truck freight tonnage was up 1%. The strength of recovery in commercial-vehicle demand remains subject to the sustainability of economic recovery in many markets. Also, although the average age of the U.S. Class 8 truck fleet remains near historically high levels, we believe trucking companies could allow their fleets to age further in this economic cycle if the recovery in freight tonnage falters. During its third quarter ended Sept. 30, 2012, Accuride's sales decreased 10.6% because of lower product demand from commercial-truck and aftermarket customers. Adjusted EBITDA margins for continuing operations were 5% compared with 8% a year earlier, mainly as a result of reduced sales and the adverse impact of operational inefficiencies. Liquidity We believe the company has "adequate" sources of liquidity to cover its needs next year, even in the event of unforeseen EBITDA declines.
Our assessment of the company's liquidity incorporates the following expectations and assumptions:
-- We expect Accuride's sources of liquidity, including cash and facility availability, to exceed uses by 1.2x or more over the next 12 to 18 months.
-- Accuride has no financial covenants unless undrawn availability drops below $10 million or 15% of the facility's size; it must then maintain a fixed-charge coverage ratio of at least 1.1x.
-- Because of the company's good conversion of EBITDA to discretionary cash flow, we believe it could absorb low-probability, high-impact shocks. As of Sept. 30, 2012, liquidity sources included $20.3 million in cash, and revolving facility availability was $59.4 million.
The company has recently increased the commitment under it asset-based revolving credit facility to $100 million from $75 million, governed by a borrowing-base formula with sublimits of up to $10 million for swingline loans. The company is permitted to use the revolving facility for letters of credit up to $25 million. Free cash flow during the first nine months of 2012 was a negative $37.6 million and somewhat less negative for all of 2012. We believe free operating cash flow will be breakeven in 2013, partly because of lower capital expenditures. We expect the company to incur capital expenditures of about $65 million in 2012 to invest primarily in its Gunite business and expand its aluminum manufacturing capacity in the U.S. and Mexico.
There are no near-term debt maturities and no mandatory amortization. The revolving credit facility matures in 2014, and secured notes mature in 2018. Recovery analysis For the full recovery analysis, please see the recovery report on Accuride Corp., to be published after this report on RatingsDirect. Outlook Our outlook on Accuride is negative. We assume commercial-truck demand in North America will fall for the rest of 2012 and into 2013. We expect free cash flow to be negative in 2012 given the company's investments to strengthen its Wheels business and fix the Gunite business. However, we expect free cash flow to be breakeven in 2013. We could lower our rating if total cash plus revolving credit availability falls significantly below $50 million.
If the economy weakens in 2013 and commercial truck demand continues to decline, or if the company loses a significant level of business from major customers, free cash flow could fall below our expectations and further pressure liquidity. For example, if we believed the company would burn $20 million or more in cash flow in 2013, we could lower the rating. In mid-2014 the company begins to face debt maturities. We could raise the ratings if Accuride reduces leverage--as measured by debt to EBITDA including our adjustments--to or below 5x and produces consistent free operating cash flow that increases total liquidity comfortably above $50 million or more. For example, if the company were to expand gross margins to 10% or better, and revenues rose at least 5%, we estimate that leverage (including our adjustments) could approach 5x or better. In such a scenario, we could revise our assessment of the financial risk profile to "aggressive" from highly leveraged, and, under our criteria, this could support an upgrade of one notch.
The company would also need to refinance its 2014 maturities.
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
Downgraded; Outlook Negative
Corporate Credit Rating B-/Negative/-- B/Stable/--
Senior Secured B- B
Recovery Rating 4 4