Fitch Affirms Meritor's IDR at 'B'; Outlook Stable
CHICAGO -- November 25, 2013
Fitch Ratings has affirmed Meritor Inc.'s (MTOR) Issuer Default Rating (IDR)
of 'B' and its various issue ratings. A full list of the rating actions is
included at the end of this release. MTOR's ratings apply to a $429 million
secured revolving credit facility, a $45 million secured term loan A, and $1.1
billion in senior unsecured notes.
KEY RATING DRIVERS
MTOR's ratings reflect the company's relatively strong market position as a
supplier of axles and brakes to the highly cyclical capital goods sector.
Credit protection metrics have weakened over the past two years as demand in
the global truck and industrial equipment markets has slumped. Against this
challenging backdrop, the work that MTOR has undertaken to improve its
profitability has begun to show results, with the company's EBITDA margin
rising sequentially throughout fiscal year (FY) 2013, while revenue for the
year declined 16%. Nonetheless, MTOR's margins continue to be relatively low
for the capital goods industry. Looking ahead, the company has embarked on a
strategy called 'M2016' that it hopes will improve financial flexibility by
increasing sales, growing margins, and reducing balance sheet obligations.
As noted, revenue declined 16% in FY2013, but the rate of decline slowed
through the course of the year as the company began to lag the significant
declines that occurred in the second half of FY2012 (2H'12). Revenue in the
4Q'13 was down 7.8%, while revenue in the 1Q'13 was down sharply at 23%.
Revenue was down in both of the company's segments, with economic uncertainty
in virtually all regions affecting demand in both the Commercial Truck &
Industrial and Aftermarket & Trailer segments. Revenue is currently expected
to be flat in FY2014 as global economic conditions stabilize, but without any
expected near-term catalysts to drive a meaningful increase in global demand.
Also pressuring demand in FY2014 will be a further ramp-down of the U.S.
Military's Family of Medium Tactical Vehicles (FMTV) program, with orders
projected to decline by 55% in FY2014 after falling approximately 30% in
MTOR has responded to the weakened market conditions by undertaking a number
of margin-enhancing initiatives over the past two years, the most notable of
which is the M2016 plan announced in April 2013. In general, Fitch views the
M2016 plan as a positive move that will help define the company's strategic
direction over the next three fiscal years. The specific objectives of M2016
include growing adjusted EBITDA margins (according to MTOR's calculations) to
10%; reducing net debt (including retirement obligations) to less than $1.5
billion; and booking an incremental $500 million in annual revenue (at run
rate). The EBITDA margin target is for the full year FY2016 based on an
expected $4.5 billion in FY2016 revenue. Fitch notes that the $500 million per
year in incremental revenue is a gross figure that does not account for any
business that might be lost over the next three fiscal years. It also
represents booked revenue, with about half of it not likely to be recognized
until after FY2016.
Despite the weak market conditions that MTOR has faced over the past two
years, it continues to have solid financial flexibility. The company's
liquidity position at Sept. 30, 2013, was relatively strong and included $318
million in cash and cash equivalents, full availability of $429 million on its
revolver, and a full $100 million of availability on its receivables
securitization facility. Cash obligations tied to debt maturities are minimal
until FY2015, when $84 million in notes comes due.
Free cash flow (FCF) in FY2013 was heavily negative, at $150 million, but this
included $54 million in voluntary pension contributions and $33 million in
cash taxes tied to the sale of the company's 50% interest in its Suspensys
Sistemas Automotivos Ltda. (Suspensys) joint venture. Proceeds from the
Suspensys sale, which totaled $190 million in cash and $5 million in lease
abatements, are not included in the FCF calculation, although the proceeds
were used to fund the tax payment and the pension contribution. Also included
in the FY2013 FCF calculation is $26 million of cash restructuring payments
and $15 million of cash outflows related to discontinued operations. Excluding
all of the unusual items, FCF from continuing operations in FY2013 would have
been negative $22 million. FCF in FY2014 is likely to be pressured by
continued market weakness and restructuring actions, but is likely to be
substantially improved from FY2013. Notably, following the voluntary pension
contributions made in FY2013, MTOR is not expected to have any required
contributions to its U.S. qualified and U.K. pension plans in FY2014.
As of the end of FY2013, the face value of MTOR's balance sheet debt stood at
$1.1 billion, in line with the level at the end of FY2012. In the 4Q'13, MTOR
used a portion of the proceeds from the Suspensys sale to make an optional
prepayment on its secured term loan A, reducing the balance on the loan to $45
million. Fitch-calculated EBITDA declined to $203 million in FY2013 from $269
million in FY2012, as the weaker market conditions drove a decline in both
revenue and the EBITDA margin. Fitch-calculated leverage
(debt/Fitch-calculated EBITDA) rose to 5.6x from 4.2x in the year-earlier
period on the EBITDA decline. EBITDA interest coverage declined to 1.6x from
2.8x year-over-year as well. Credit protection metrics are likely to improve
modestly in FY2014 on a slight increase in EBITDA as margins increase slightly
on roughly flat revenue. The de-levering objective in the M2016 plan suggests
that the company will look for additional opportunities to reduce its debt
over the next three years. Fitch notes that the company has the ability to
prepay the remaining amount outstanding on its term loan A without penalty.
Fitch's calculation of EBITDA differs from MTOR's 'Adjusted EBITDA'
calculation, primarily because Fitch's figures do not include equity in
earnings of affiliates, while MTOR's figures include those earnings. Equity in
earnings of affiliates was $42 million in FY2013, down from $52 million in
FY2012. In addition to its balance sheet debt, MTOR utilizes several
off-balance-sheet factoring programs, and these sales are not included in the
leverage figures above. As of Sept. 30, 2013, MTOR had utilized $305 million
of off-balance-sheet program availability, of which $264 million was through
committed facilities related to receivables from AB Volvo.
The funded status of MTOR's pension plans improved in FY2013 as a result of
de-risking initiatives, higher long-term interest rates and the aforementioned
optional prepayment made in the fiscal fourth quarter. As of Sept. 30, 2012,
the company's global plans were 80% funded, with a shortfall of $341 million.
The company's U.S. plans, however, were only 70% funded, with a projected
benefit obligation that exceeded the value of plan assets by $307 million.
Although improved, the underfunded position of MTOR's pension plans continues
to weigh on the ratings, although the company is not expected to have any
required contributions in the U.S. in FY2014 as a result of the FY2013
prepayment. In FY2013, MTOR contributed a total of $115 million to its global
plans, including the voluntary contribution and $49 million in contributions
to non-U.S. plans. Over the longer term, rising interest rates will help to
reduce MTOR's pension contribution requirements.
The rating of 'BB/RR1' on MTOR's secured revolver and term loan A reflects its
substantial collateral coverage and outstanding recovery prospects, estimated
in the 90% to 100% range, in a distressed scenario. Collateral for the
revolver and term loan includes hard assets, accounts receivable, intellectual
property, and investments in certain subsidiaries. As of Sept. 30, 2013, MTOR
valued the assets backing the facility at $607 million. The rating of 'B-/RR5'
on the company's unsecured notes reflects Fitch's expectation that recovery
would be below average, in the 10% to 30% range, in a distressed scenario. The
lower level of expected recovery for the unsecured debt is due, in part, to
the substantial amount of higher-priority secured debt in MTOR's capital
structure, including the potential for a full draw on both the secured
revolver and the U.S. accounts receivable securitization facility.
Positive: Future developments that may, individually or collectively, lead to
a positive rating action include:
--A decline in leverage to below 4.0x for a sustained period;
--An ability to produce positive free cash flow on a consistent basis;
--An increase in margins as a result of restructuring actions.
Negative: Future developments that may, individually or collectively, lead to
a negative rating action include:
--A material further deterioration in the global commercial truck or
industrial equipment markets;
--An extended period of negative operating cash flow that substantially
reduces the company's liquidity;
--An unexpected acquisition that leads to an increase in leverage;
--An increase in debt to fund shareholder-friendly activities.
Fitch has affirmed the following ratings with a Stable Outlook:
--IDR at 'B';
--Secured credit facility rating at 'BB/RR1';
--Senior unsecured rating at 'B-/RR5'.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--Corporate Rating Methodology (Aug. 5, 2013);
--Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
(Nov. 19, 2013);
--Evaluating Corporate Governance (Dec. 12, 2012);
--Treatment of Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis (Dec. 13, 2012).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Evaluating Corporate Governance
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
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Fitch Ratings, Inc.
Stephen Brown, +1-312-368-3139
70 West Madison Street, Chicago, IL 60602
Craig D. Fraser, +1-212-908-0310
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