CHICAGO--()--Fitch Ratings has affirmed the 'B+' Issuer Default Rating (IDR) and the various issue ratings of The Goodyear Tire & Rubber Company (GT) and its Goodyear Dunlop Tires Europe B.V. (GDTE) subsidiary. A full list of the ratings is included at the end of this release.
GT's ratings apply to a $2 billion secured revolving credit facility, a $1.2 billion second lien secured term loan and $2.1 billion of senior unsecured notes. GDTE's ratings apply to a Eur400 million secured revolving credit facility and Eur250 million of senior unsecured notes. The Rating Outlooks for GT and GDTE are Stable.
KEY RATING DRIVERS
GT's ratings reflect the company's strong competitive position as the third-largest global manufacturer of replacement and original equipment (OE) tires. Although the company's unit volumes declined in 2012 in three of its four global regions, positive pricing and mix helped to partially offset the effect on revenue and margins. Despite GT continuing to post negative free cash flow, the company has maintained a relatively strong liquidity position, and refinancing activities over the past two years have left it without any significant near-term debt maturities. Fitch expects only modest improvement in GT's credit protection metrics over the intermediate term, however, as tire industry conditions remain challenged by economic weakness in Europe, slower growth in emerging markets and increased competitive manufacturing capacity. An expected increase in debt to pre-fund a portion of the company's underfunded U. S. pension plans will also lead to higher leverage, although it will reduce volatility tied to discount rates and asset returns.
Concerns include persistently negative free cash flow, heavily underfunded pension plans and upcoming labor negotiations in the U.S. Relatively large swings in working capital throughout the year also are a concern, as the company relies on fourth quarter inflows to support its full-year operating cash flow. Although the company's profitability in North America exceeded its expectations in 2012, the European market has lagged expectations, and upcoming labor negotiations in the U.S. with the United Steelworkers union (USW) introduce a near-term risk of labor actions or increased costs resulting from a new contract that could lower margins in the company's strongest market.
Fitch expects global tire market conditions to remain challenging over the intermediate term, which could constrain GT's top line growth potential for the next several years. In particular, continued economic weakness in Europe and slower economic growth in several key emerging markets, especially China and India, will be a demand headwind. Growth in global tire manufacturing capacity is also expected to put pressure on pricing, as will increasing competition from rising Asian tire manufacturers. Longer term, however, continued growth in the global car parc will drive increased replacement and OE tire demand, while increasingly affluent consumers in emerging markets will increase global demand for premium tires, both of which will support GT's sales.
In 2011, GT began work on a multi-year profit improvement program intended to grow its consolidated segment operating income (as calculated by GT) to $1.6 billion in 2013. Progress in North America has been running ahead of plan, and the region posted segment operating income of $514 million in 2012, higher than the company's target for 2013 of $450 million. Progress outside North America, however, has been hindered by the weak European market, and the company has revised its 2013 guidance down to total segment operating income of $1.4 billion to $1.5 billion in 2013. Although GT will likely not achieve its original 2013 profitability objective, the margin improvement already achieved in North America will help to reduce near-term cash burn despite continued European weakness.
GT's pension plans remain substantially underfunded, due to a combination of falling discount rates and a history of funding the plans at the statutory minimums. Despite contributing $1.4 billion to its U.S. plans over the past five years, GT's U.S. plans were still underfunded by $2.7 billion at year-end 2012, which was up from $2.5 billion at year-end 2011. To address the underfunded status, GT plans to issue debt to pre-fund its U.S. pension obligations once the plans are frozen. GT's salaried plan, which constituted $1 billion of the underfunded position at year-end 2012, has already been frozen, and the company could potentially issue debt in the near term to pre-fund these obligations. GT plans to work on freezing its non-salaried U.S. pension plans, as well, and if that is completed successfully, it could issue debt to fund those obligations, as well. Fitch notes that freezing the non-salaried plans could be complicated and will likely be an additional challenge to overcome in the upcoming USW negotiations.
In addition to the pre-funding, the company is also de-risking its plans by shifting the asset mix to a greater use of fixed income investments and hedging some of its other assets, with a long-term goal funding the plans with an asset mix that reflects the securities used to calculate the discount rate. In general, Fitch views GT's focus on its pensions as a credit positive, as the underfunded position of the plans has weighed on the company's ratings for a number of years. However, the additional debt added to the company's capital structure will be substantial and will result in an increase in Fitch's calculation of leverage. Also, the interest rate on the debt will likely exceed the potential returns of the fixed income assets that the proceeds are used to acquire, although the present value loss of these actions could be preferable to the cost of the volatility that would be experienced if the plans are not pre-funded.
In 2012, GT's net revenue declined 7.8% to $21 billion on a 9.2% decline in global tire unit sales. Sales weakness was most pronounced in Europe where poor economic conditions drove unit sales down nearly 16% and revenue down by about 14%. However, unit sales also declined in North America and Latin America as the company continued to focus on producing higher-margin premium tires. In emerging markets, tire sales were also constrained by weaker market conditions and increased competitive pressures. Helping to offset the effect of the decline in sales volumes were improved pricing and positive mix changes in each region. This was especially visible in North America, where pricing and mix added $500 million to revenue despite a 5.2% decline in sales volumes.
On an EBITDA basis, GT's leverage (debt/Fitch-calculated EBITDA) at the end of 2012 was flat with year-end 2011 at 2.8 times (x) as both debt and EBITDA declined slightly. However, funds from operations (FFO) adjusted leverage rose to 6.1x from 3.9x as FFO (including preferred dividends) declined to $552 million in 2012 from $1.4 billion in 2011. Balance sheet debt, including notes payable and overdrafts, was $5.1 billion at Dec. 31, 2012, down from $5.2 billion at Dec. 31, 2011. Fitch-calculated EBITDA for the full year 2012 was $1.8 billion, down from $1.84 billion in the year-earlier period, although the company's EBITDA margin rose to 8.6% from 8.1%.
As noted above, GT's leverage tends to rise and fall during the year as the company borrows in periods when working capital is negative. During 2012, EBITDA leverage was as high as 3.5x at the end of the third quarter before declining to the year-end level as the company repaid credit facility borrowings with cash generated from positive working capital. Fitch notes that the magnitude of working capital swings has declined somewhat over the past year as the company has worked to reduce working capital volatility.
GT's liquidity position at Dec. 31, 2012, was relatively strong, with $2.3 billion in cash and cash equivalents and another $1.7 billion available on the company's primary U.S. and European revolvers. This was well above the $1 billion level that management has previously identified as the minimum necessary to meet the company's working capital needs and overseas funding requirements through the cycle. Following refinancing transactions undertaken during 2012, GT has no significant debt maturities until 2019, although its European accounts receivable facility matures in 2015 and its European and U.S. revolvers mature in 2016 and 2017, respectively.
Free cash flow in 2012 was negative $118 million, an improvement from negative $285 million in 2011, largely due to the effect of inventory changes, which were a $619 million source of cash in 2012 versus a $1 billion use of cash in 2011. Fitch expects free cash flow to be pressured again in 2013, as challenging market conditions outside the U.S., along with elevated capital spending, weigh on GT's cash-generating potential. Pension contributions are also likely to be a meaningful use of cash, particularly if the company pre-funds a significant portion of its obligations, as planned. Nonetheless, Fitch expects liquidity to remain more than sufficient for the company's operations over the intermediate term.
The rating of 'BB+/RR1' on GT's and GDTE's secured credit facilities reflects their substantial collateral coverage and outstanding recovery prospects in the 90% to 100% range in a distressed scenario. On the other hand, the rating of 'B/RR5' on GT's unsecured notes reflects Fitch's expectation that recoveries would be below average, in the 10% to 30% range, in a distressed scenario. The relatively low level of expected recovery for the unsecured debt is due to the substantial amount of higher-priority secured debt in the company's capital structure. Fitch also notes that in a distressed scenario, GT's substantial pension obligations could potentially depress recovery prospects further for the company's unsecured creditors.
The rating of 'BB/RR2' on GDTE's senior unsecured notes is higher than the rating on GT's unsecured notes due to structural seniority. GDTE's notes are guaranteed on an unsecured basis by GT and GT's subsidiaries that also guarantee the parent company's secured revolver and second lien term loan. Although GT's senior unsecured notes also include guarantees from the same subsidiaries, they are not guaranteed by GDTE. The recovery prospects of GDTE's notes are further strengthened relative to those at GT by the lower level of secured debt at GDTE. Fitch notes that GDTE's credit facility and its senior unsecured notes are subject to cross-default provisions relating to GT's material indebtedness.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--The company producing positive annual free cash flow on a sustained basis;
--An increase in the company's global margin performance;
--A sustained decline in leverage;
--A substantial improvement in the funded status of the company's pension plans.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A significant decline in demand for the company's tires;
--An unexpected increase in costs, particularly related to raw materials;
--A labor action stemming from the company's USW negotiations;
--A decline in the company's cash liquidity below $1 billion;
--A significant increase in long-term debt, particularly to support shareholder-friendly activities.
Fitch has taken the following rating actions on GT and GDTE with a StableOutlook:
--IDR affirmed at 'B+'
--Secured bank credit facility rating affirmed at 'BB+/RR1';
--Secured second-lien term loan rating affirmed at 'BB+/RR1';
--Senior unsecured ratings affirmed at 'B/RR5'.
--IDR affirmed at 'B+';
--Secured bank credit facility rating affirmed at 'BB+/RR1';
--Senior unsecured rating affirmed at 'BB/RR2'.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Applicable Criteria and Related Research:
--Corporate Rating Methodology (Aug. 8, 2012);
--Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (Nov. 13, 2012);
--Evaluating Corporate Governance (Dec. 12, 2012);
--Treatment of Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis (Dec. 13, 2012);
--2013 Outlook: U.S. Auto Manufacturers and Suppliers (Dec. 17, 2012).
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
2013 Outlook: U.S. Auto Manufacturers and Suppliers
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Evaluating Corporate Governance