October 16, 2017 / 3:28 PM / 2 months ago

Fitch Affirms Allison Transmission's IDR at 'BB'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 16 (Fitch) Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Allison Transmission Holdings, Inc. (ALSN) and its Allison Transmission, Inc. (ATI) subsidiary at 'BB'. Fitch has also affirmed ATI's secured revolving credit facility and secured B-3 term loan ratings at 'BB+'/'RR1' and ATI's senior unsecured notes rating at 'BB'/'RR4'. Fitch's ratings apply to a $550 million secured revolving credit facility (RCF), a $1.2 billion secured term loan and $1.4 billion in senior unsecured notes. The Rating Outlooks for ALSN and ATI are Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS The ratings of ALSN and ATI continue to be supported by the company's high margins and strong FCF, set against a backdrop of elevated leverage. ALSN continues to lead the global market for fully automatic transmissions for commercial vehicles, off-road machinery and military equipment. ALSN's market position in North America remains very strong, with 92% of the school buses and 70% of the medium-duty commercial trucks manufactured in the region delivered with the company's transmissions in 2016. In addition, 63% of the Class 8 straight trucks and 36% of the Class A motorhomes produced in North America in 2016 were manufactured with the company's transmissions. ALSN's transmissions command a price premium, and Fitch expects the market for commercial vehicle automatic transmissions in North America to increase over time. Outside North America, ALSN's market position is significantly smaller, as the penetration of automatic transmissions in commercial vehicles remains relatively low. However, acceptance of fully automatic transmissions is increasing outside North America. This has been especially true in certain emerging markets like China and India, where ALSN is well positioned for future growth opportunities. Over the longer term, Fitch expects automatic transmissions to gain in popularity among commercial vehicle end users outside North America for the same reasons that automatic transmissions are increasingly used in North America, namely ease-of-use and fuel efficiency. Rating concerns include the heavy cyclicality of the global commercial vehicle and off-highway equipment markets, volatile raw material costs, the relative lack of global diversification in ALSN's current business mix, and moderately high leverage. However, it is notable that the company's transmissions are used primarily in the vocational truck market, which is generally less cyclical than the Class 8 linehaul tractor market. Nonetheless, a broad-based global downturn in commercial vehicle or off-road equipment demand would pressure ASLN's margins and FCF. Competition in the industry has risen with the increased penetration of automated manual transmissions (AMTs), which poses some further risk to ALSN over the intermediate term. Over the much longer term, the potential introduction of electric trucks, particularly for use in urban areas, could pose a risk as well, although ALSN's experience in manufacturing propulsion systems for hybrid buses gives it an understanding of the technology requirements of electrified powertrains. On the other hand, the potential for driverless long-haul truck platooning using diesel-powered tractors could increase the future market for automatic transmissions in Class 8 linehaul tractors. Platooning experiments are currently underway in several countries. Fitch expects ALSN's EBITDA leverage (debt/Fitch-calculated EBITDA) to run in the low- to mid-3x range over the intermediate term, while FFO adjusted leverage will likely run in the mid- to high-3x range. Both leverage metrics are somewhat elevated for the rating category. EBITDA leverage should run near the lower end of the expected range in the near term, despite higher debt levels, as a result of strengthening demand in several of the company's end markets driving EBITDA higher. However, FFO adjusted leverage could run at the higher end of the range in the near term, as FFO is weighed down somewhat by higher cash taxes. As of June 30, 2017, ALSN's EBITDA leverage was 3.3x, while FFO adjusted leverage was 3.4x. Despite weaker end-market demand in the latter half of 2016, ALSN's profitability has remained very strong by industry standards, with an EBITDA margin of 36.7% in the LTM ended June 30, 2017. ATI's recent issuance of $400 million in senior unsecured notes, with proceeds earmarked for general corporate purposes, increased the company's leverage above the June 30, 2017 level. Pro forma for the incremental debt, EBITDA leverage at June 30, 2017 would have been 3.8x. However, Fitch expects leverage to decline back toward recent historical levels over the near- to intermediate-term. The addition of another series of senior unsecured notes further diversifies ALSN's capital structure. As of June 30, 2017, the company had $205 million outstanding on its revolver, and the company could choose to use a portion of the proceeds from the new notes to repay those borrowings. Although ALSN's leverage is high for its rating category, the effect on its credit profile is mitigated by the company's very strong profitability and FCF generation, which provides ALSN with significant financial flexibility. Fitch expects ALSN to continue producing strong FCF over the intermediate term, with post-dividend FCF margins generally running in the high teens, which is quite strong for a capital goods-related supplier. ALSN's capital spending needs are relatively low, and Fitch expects its capital intensity (capital spending/revenue) to run at about 4% over the intermediate term. Fitch expects the company will deploy much of its post-dividend FCF toward share repurchases, with some further debt reduction, as the company's term loan amortizes. FCF after dividends in the LTM was $416 million, equal to a very strong 21% FCF margin, although as noted, Fitch expects FCF margins to moderate somewhat going forward. Over the past several years, ALSN has begun returning more cash to shareholders through dividends and share repurchases. In November 2016, ALSN's board of directors authorized the company to repurchase up to $1 billion in shares through year-end 2019, and in February 2017, ALSN repurchased the entire stake in the company held by ValueAct Capital for $363 million as part of the $1 billion repurchase authorization. Largely as a result of that block share repurchase, the net amount the company spent on share repurchases in the LTM was $671 million, well above the amount ALSN typically spends on repurchases. The company funded the repurchase of the ValueAct shares with revolver borrowings and cash on hand. Fitch expects that ALSN will continue to target most of its excess cash toward share repurchases, although Fitch also expects the company would pull back on repurchases if it needed to conserve liquidity. ALSN has drawn interest from activist investors over the past several years. As noted above, ValueAct no longer has a stake in the company, and its representative did not stand for re-election at ALSN's last annual meeting. However, Ashe Capital Management continues to hold a 6.6% stake according to ALSN's most recent proxy filing, and the company's shareholders elected a representative of Ashe to the company's board at ALSN's 2017 annual meeting. Although the potential influence of activists is a concern, Fitch does not expect them to drive any significant decisions detrimental to the company's creditors. However, Fitch acknowledges that the repurchase of ValueAct's stake constituted a relatively large use of cash and drove a slight increase in leverage that Fitch views as temporary. ALSN's pension obligations are modest, with an underfunded status of only $4.5 million as of year-end 2016. The company's salaried pension plan was closed to new entrants in 2007, and its hourly plan was closed to new entrants in 2008. Benefits for hourly employees who retired prior to Oct. 2, 2011 are covered under General Motors Company's hourly plan. Fitch does not view ALSN's pension obligations as a meaningful credit risk. ATI's secured revolver and B-3 term loan are rated 'BB+'/'RR1', one notch above ATI's IDR, reflecting Fitch's expectations for outstanding recovery prospects of around 91%-100% in a distressed scenario. This is due, in part, to their collateral coverage, which includes virtually all of ATI's assets. Fitch notes that property, plant, and equipment and intangible assets (including intellectual property) composed about $1.7 billion of the $4.1 billion in assets on ALSN's consolidated balance sheet at June 30, 2017. DERIVATION SUMMARY ALSN is among the smaller public capital-goods suppliers, with a more focused and less diversified product offering. Compared with suppliers such as Cummins, Inc., Dana Incorporated (bb+*/Stable*), or Meritor, Inc. (B+/Stable), ALSN is smaller, with sales that are less geographically diversified, as nearly 70% of ALSN's revenue is derived in the U.S. That said, its share in many of the U.S. end-market segments where it competes is very high, with over 50% of the vehicles in certain segments fitted with ALSN's transmissions. Compared with other industrials in the 'BB' rating category, such as Tenneco Inc. (BB+/Stable) or The Goodyear Tire and Rubber Company (BB/Stable), ALSN's leverage is relatively high, but this is offset by very strong margins and FCF generation. ALSN's EBITDA leverage is roughly 0.5x-1.0x higher than many 'BB' category issuers in the capital goods or auto supply industries. However, its strong EBITDA margins are about double those of many investment-grade capital goods or auto supply issuers, such as BorgWarner Inc. (BBB+/Stable), while its post-dividend FCF margins are about four to five times higher than many of those higher-rated issuers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Global end-market demand strengthens in 2017, following weak conditions in 2015 and 2016, leading to revenue growth in the mid-teens. --Beyond 2017, market conditions remain generally favorable, leading to more normalized revenue growth in the low-single-digit range. --EBITDA margins remain strong through the forecast, at around mid-30%, on higher demand levels, positive pricing and continued cost control. --The company repays outstanding revolver borrowings by year-end 2017. --Debt declines over the next several years as the company makes amortization payments on its term loan. --Capital spending runs at about 4% over the next few years, roughly consistent with historical levels. --Total dividend spending is flat, assuming that any increases in the dividend rate are offset by a lower share count. --The company generally maintains a strong cash position, with excess cash used for share repurchases. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --A decline in Fitch-calculated EBITDA leverage to below 3.0x; --An increase in the global diversification of its revenue base; --Maintaining EBITDA and FCF margins at or above current levels; --Continued positive FCF generation in a weakened demand environment. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --A sustained significant decline in EBITDA margins or an extended period of negative FCF; --A competitive entry into the market that results in a significant market share loss; --An increase in Fitch-calculated EBITDA leverage to above 4.0x for a prolonged period; --A merger or acquisition that results in higher leverage or lower margins over an extended period. LIQUIDITY Fitch expects ALSN's liquidity to remain adequate over the intermediate term. At June 30, 2017, the company had $85 million in cash and cash equivalents, which was lower than normal, although the company's strong FCF-generating capability could allow it to increase its cash balance in a relatively short period of time. Typically, the company has carried between $150 million and $300 million in cash on its balance sheet. In addition to its cash, ALSN had $227 million in availability on ATI's secured RCF at June 30, 2017 (prior to its upsizing) after accounting for $205 million in borrowings and $18 million in letters of credit backed by the facility. In September 2017, ALSN upsized the revolver to $550 million from $450 million. Based on its criteria, Fitch treats non-U.S. cash, as well as and cash needed to cover seasonal changes in working capital and other obligations, as "not readily available" for purposes of calculating net metrics. Fitch believes that ALSN's operating cash flow is sufficient to cover the company's primary cash needs even in the weakest period of a typical year, so seasonality is not a significant factor in Fitch's calculation of this metric. Therefore, Fitch only treats non-U.S. cash as "not readily available" in its calculations. As of June 30, 2017, $57 million of ALSN's $85 million cash balance was outside the U.S., leaving $28 million in "readily available cash". Fitch expects this will increase significantly over the intermediate term as the company's consolidated cash balance rises back to historical levels. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings with a Stable Outlook: Allison Transmission Holdings, Inc. --Long-term IDR at 'BB'. Allison Transmission, Inc. --Long-term IDR at 'BB'; --Secured revolving credit facility rating at 'BB+/RR1'; --Secured term loan rating at 'BB+/RR1'; --Senior unsecured notes rating at 'BB/RR4'. Contact: Primary Analyst Stephen Brown Senior Director +1 312 368 3139 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Eric Ause, CFA Senior Director +1 312 606 2302 Committee Chairperson Mark Sadeghian, CFA Senior Director +1 312 368 2090 Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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