CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed Meritor Inc.'s (MTOR) Issuer Default Rating (IDR) at 'B' and its senior secured credit facility rating at 'BB/RR1'. Fitch has also upgraded MTOR's senior unsecured notes rating to 'B/RR4' from 'B-/RR5'. A full list of the rating actions is included at the end of this release. MTOR's ratings apply to a $499 million secured revolving credit facility and $1 billion in senior unsecured notes. Fitch has revised MTOR's Rating Outlook to Positive from Stable.
KEY RATING DRIVERS
MTOR's ratings reflect the company's relatively strong market position as a supplier of axles and brakes in the highly cyclical commercial and off-road vehicle sectors. Although the company's top line has been pressured by weak global market conditions over the past several years, the company's profitability and credit protection metrics have begun to improve as the company's M2016 plan gains traction. Over the past two years, the company has used free cash flow (FCF) and proceeds from stake sales to reduce debt and improve the funded status of its pension plans, and in fiscal year (FY) 2014, it used proceeds from its share of a legal settlement with Eaton Corporation plc (Eaton) to further bolster its pension plans. Looking ahead, Fitch expects MTOR's financial flexibility to improve as it continues to lower its cost structure and strengthen its balance sheet.
Despite the underlying improvement in MTOR's operations and financial profile, Fitch continues to have significant concerns. The global commercial and off-road vehicle markets remain highly cyclical, and although the North American commercial truck market is near its cyclical peak, the South American, European and Asian markets are relatively weak and likely to remain so over the intermediate term. This will constrain MTOR's ability to grow revenue over the next couple of years, as will declining defense-related demand. Although MTOR's more-flexible cost structure is better equipped to manage through market cycles, tepid demand in certain regions could make reaching some of the company's M2016 goals more challenging.
Competition in the industry remains high as well, and new business wins were a little lighter than expected in FY2014. That being said, MTOR successfully renewed its multi-year supply agreements with AB Volvo and Daimler AG during FY2014, helping to cement much of its core commercial vehicle business for the next several years.
Following two years of declining sales, MTOR's revenue grew modestly in FY2014. Higher-than-expected commercial truck and trailer demand in North America was largely responsible for a 2.6% increase in MTOR's revenue to $3.8 billion, up from $3.7 billion in FY2013. Looking ahead, Fitch expects revenue in FY2015 to remain pressured and roughly flat with the FY2014 level despite the potential for further modest growth in the North American market. Notably, Class 8 commercial truck production was near its cyclical peak, reaching about 281,000 units in FY2014, only about 19,000 units below the roughly 300,000-unit maximum production capacity of the North American industry. This may constrain North American revenue growth potential in FY2015, as will ongoing weakness in the South American market and potential weakness in Western Europe. The expected end of the U.S. military's Family of Medium Tactical Vehicles (FMTV) program in mid-2015 will also pose a revenue headwind in FY2015. Potential bright spots are India, where demand appears to be strengthening, and China, where demand for construction equipment demand could see a modest increase.
In FY2013, MTOR launched its M2016 plan, which packages a number of initiatives intended to increase profitability, grow FCF and strengthen the company's balance sheet by year-end FY2016. Fitch continues to view the M2016 plan positively, and the company appears fully committed to it. In general, the company appears on track to meet its profitability objectives, although the amount of incremental business booked in FY2014, at $145 million, was negatively affected by market conditions. However, MTOR has stated that ongoing work on its cost structure could allow it to reach its 10% adjusted EBITDA target if it can achieve revenue greater than $4.2 billion in FY2016. Although the profitability target could be challenged, the $1.5 billion net debt target (including pension liabilities) has already been achieved, two years early, following the prepayment of its pension plans and several debt redemptions in FY2014.
With the achievement of its debt target, MTOR's financial flexibility has improved. MTOR's liquidity position at year-end FY2014 was relatively strong and included $247 million in cash and cash equivalents, full availability of $499 million on its secured revolver, and $86 million available on its $100 million North American receivables securitization facility. Cash obligations tied to debt maturities are minimal until FY2019, although the company's remaining $55 million in 4.625% convertible notes due 2026 have a put and call feature that allows for early redemption beginning in March 2016.
MTOR produced positive FCF in FY2014 following three years of negative FCF. The FY2014 figure included $209 million in cash proceeds received from the Eaton settlement, offset by $134 million of discretionary pension contributions that prefunded the next three years of required contributions to its U.S. and UK pension plans. Also included in the FY2014 FCF calculation was $10 million of cash restructuring payments and $12 million of cash outflows related to discontinued operations. Excluding these various non-recurring items, FCF from continuing operations in FY2014 would have been $85 million. In the intermediate term, FCF is likely to be pressured by the aforementioned top-line pressures and continued restructuring actions, but Fitch expects FCF to be positive on a full-year basis, supported by the company's improved cost structure, lower cash interest payments and the lack of required U.S. and UK pension contributions.
In conjunction with the Eaton settlement, MTOR announced that its Board had authorized the repurchase of up to $210 million in equity or equity-linked securities once the M2016 debt reduction target was met. Although Fitch has some concerns regarding the repurchase program, particularly given MTOR's current rating level, Fitch expects the company to be judicious in administering the program, and it appears to remain committed to reducing leverage and maintaining a strong liquidity position. Fitch also notes that the MTOR's convertible debt could be considered 'equity-linked' for purposes of the program.
At year-end FY2014, the principal value of MTOR's balance sheet debt stood at $1 billion, down from $1.2 billion at year-end FY2013, as the company repaid the remaining $45 million on its secured Term Loan A, the remaining $84 million on its $8.125% senior unsecured notes, $38 million of its 4% convertible notes and the full $250 million of its 10.625% notes. Much of this was funded via FCF, although the company did issue $225 million in 6.25% notes during the year to help fund the 10.625% note redemption. In addition to its balance sheet debt, MTOR also utilizes several off-balance-sheet factoring programs in Europe. As of year-end FY2014, MTOR had factored $244 million of its receivables in off-balance-sheet programs.
Fitch-calculated EBITDA rose to $304 million in FY2014 from $208 million in FY2013, as the improvements in the company's cost structure drove an increase in its EBITDA margin despite continued pressure on revenue. Fitch-calculated leverage (balance sheet debt/Fitch-calculated EBITDA) declined to 3.3x from 5.7x in FY2014 on the combination of lower debt and increased EBITDA. EBITDA interest coverage rose to 2.3x from 1.7x, helped by the increased EBITDA and a decline in interest expense. Fitch expects credit protection metrics to strengthen slightly in FY2015 on a slight increase in EBITDA as margins increase marginally on roughly flat revenue. Although the delevering objective in the M2016 plan has been met, Fitch expects that the company will continue look for opportunities to further reduce debt over the intermediate term.
The funded status of MTOR's pension plans improved in FY2014 as the company used proceeds from the Eaton settlement to pre-fund the next three years' required U.S. and UK contributions. Improvement in the funded status also reflected the company's de-risking initiatives. As of year-end FY2014, the company's global plans were 88% funded, with a shortfall of $219 million, up from a funded status of 80% and a $341 million shortfall at year-end FY2013. However, at year-end FY2014, the company's key U.S. plans were only 79% funded, with a $227 million net liability. The lack of required U.S. and UK pension contributions over the next three years will help to bolster MTOR's FCF by an estimated $65 million to $70 million annually and improve the company's financial flexibility. Nonetheless, the continued net pension liability, although less of a concern following the voluntary prepayments, continues to weigh on MTOR's ratings.
The rating of 'BB/RR1' on MTOR's secured revolver reflects its substantial collateral coverage and outstanding recovery prospects in a distressed scenario, which Fitch estimates in the 90% to 100% range. Collateral includes hard assets, accounts receivable, intellectual property, and investments in certain subsidiaries, which MTOR valued at $615 million as of Sept. 30, 2014. The upgrade of the senior unsecured notes rating to 'B/RR4' from 'B-/RR5' reflects the improvement in Fitch's expected recovery on the notes to a range of 30% to 50% in a distressed scenario. The improved recovery expectation stems from a higher expected post-restructuring enterprise value based on the company's improved earnings and the lower level of debt outstanding.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Maintaining EBITDA leverage below 4x and lease-adjusted leverage (lease-adjusted debt, including off-balance sheet debt/EBITDAR) below 4.5x through the cycle;
--Producing positive FCF on a consistent basis;
--Maintaining an EBITDA margin above 8% for through the cycle.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A material deterioration in the global commercial truck or industrial equipment markets for a prolonged period;
--An increase in EBITDA leverage to above 5x and lease-adjusted leverage (lease-adjusted debt, including off-balance sheet debt/EBITDAR) above 5.5x through the cycle;
--A decline in the EBITDA margin to below 6% through the cycle.
Fitch has taken the following rating actions. The Rating Outlook has been revised to Positive from Stable
--IDR affirmed at 'B';
--Secured revolving credit facility rating affirmed at 'BB/RR1';
--Senior unsecured notes rating upgraded to 'B/RR4' from 'B-/RR5'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (May 28, 2014);
--Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (Dec. 23, 2013).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage