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Sept 12 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned Conti-Gummi Finance BV’s proposed 3.5 year senior unsecured notes of a benchmark size an expected rating of ‘BBB(EXP)’. The note will be guaranteed by Continental AG (BBB/Stable/F2).
Proceeds from the proposed notes are expected to be used to refinance the early redemption of the EUR625m existing 6.5% note maturing in 2016 at significantly more favourable terms. The proposed notes will be unsecured and unsubordinated and will benefit from guarantees of various Continental operating subsidiaries.
The notes’ documentation includes a call option (make-whole) for Continental and a change of control put option, which excludes Schaeffler. It also includes covenants related to a limitation of indebtedness, restricted payments including dividends, and merger, split and sale of assets. In particular, it limits the payment of dividends and making of loans to shareholders to an aggregate EUR750m per year or 1% of its market capitalisation if it exceeds EUR10bn. The restrictions will disappear if the group is rated investment grade by at least two rating agencies.
Since July 2013, Continental AG has issued EUR1.5bn in five and seven-year Eurobonds, and has redeemed EUR2.375bn in high yield bonds issued in 2010.
The upgrade of Continental to ‘BBB’ in July 2013 reflected Fitch’s assessment of the parent subsidiary linkage between the Schaeffler Group and Continental AG.
Fitch now deems the linkage weak enough to rate Continental on a standalone basis. The linkage has been weakened by Schaeffler reducing its stake to 49.9%, Continental extending its bank debt agreement with tight ring-fencing of cash flows to 2018, and Continental’s independent dividend policy. A strengthening of the linkage is considered unlikely and would be treated as event risk.
Strong Business Profile
Continental’s ratings reflect its large manufacturing operations, global footprint, top-ranking positions in the markets in which it operates and solid end-market diversification with about 30% of sales in the less volatile replacements business.
The company’s financial profile is strong and relatively resilient against the cyclicality and volatility experienced in the automotive supply industry. Fitch expects EBITDAR margins of 15% for 2013 and thereafter. Profitability is also supported by Continental’s tyre business, which accounted for 29% of 2012 sales and resulted in an EBITDAR margin of about 19%.
Strong Free Cash Flow
The Stable Outlook reflects Fitch’s expectations for Continental’s solid underlying funds from operations (FFO) margin to remain at approximately 10% in the next couple of years. This would be sufficient to cover the high 6% capex-to-revenue outlays and the company’s conservative dividend policy. Fitch expects the free cash flow (FCF) margin to remain in the range of 2.5%-3.5% in 2013 and beyond.
The Stable Outlook is further supported by Fitch’s expectations that Continental’s FFO adjusted leverage will decrease to well under 2.0x during 2014 from 2.3x at end-2012 and from a peak of over 6.0x at end-2007.
Fitch estimates that cash and undrawn committed credit facilities amounted to around EUR4.2bn at end-June 2013. Fitch expects FCF of at least EUR1bn in 2014 and beyond. Given its liquidity generating ability, Continental has opted for early redemption since July 2013 of three bonds totalling EUR2.375bn, and issued a EUR750m bond with a 3.125% coupon maturing 2020 and a EUR750m bond with a 3% coupon maturing 2018.
Strong FCF Margins
Positive rating action may occur if, on a sustained basis, EBITDAR margins increase to above 15%, FCF margins improve to 3.0% and FFO adjusted leverage falls well below 1.5x. Fitch believes that given the independent dividend policy and some discretionary capex outlays currently, Continental has sufficient headroom to achieve these guidelines within two years.
An increase in FFO adjusted leverage to above 2.0x or FCF margins falling to or below 1% to 2% may result in negative rating action.
Any change in Schaeffler’s influence on Continental resulting in a weakening of Continental’s credit profile could lead to a reassessment of Fitch’s standalone approach to Continental’s rating. This may also occur if there is a merger of Continental AG with Schaeffler Group, and the combination led to a deterioration of the consolidated financial profile.