CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded Tenneco Inc.'s (TEN) Issuer Default Rating (IDR) to 'BB+' from 'BB'. In addition, Fitch has affirmed TEN's secured Term Loan A and secured revolving credit facility ratings at 'BBB-' and upgraded TEN's senior unsecured ratings to 'BB' from 'BB-'. A full list of the rating actions is provided at the end of this release. Fitch's ratings apply to an $850 million secured revolving credit facility, a $241 million secured Term Loan A and $725 million in senior unsecured notes. The Rating Outlook for TEN is Stable.
KEY RATING DRIVERS
The upgrade of TEN's ratings reflects the continued strengthening in the auto supplier's credit profile as global auto sales have grown and demand for the company's technologies remains strong. TEN remains a top global supplier of emission control and vehicle suspension components, with a strong presence in both the original equipment and aftermarket segments. In addition to the company's traditional light vehicle business, increasingly stringent regulations in a number of regions governing commercial truck and off-highway vehicle emissions are driving further growth opportunities and higher margins. Primary risks to the company's credit profile include industry cyclicality, which could become more pronounced as commercial vehicles comprise a larger proportion of the company's sales mix, volatile raw material costs and higher fuel prices; although the company's lowered cost structure and strengthened balance sheet have improved its ability to withstand another downturn in global demand.
Fitch expects demand for TEN's products, especially in its Clean Air division, to grow over the next several years as global emissions requirements tighten. In particular, TEN continues to capture new business in the global on-highway commercial vehicle and off-highway specialty vehicle markets as emission requirements in those segments become more restrictive. In the off-highway market, tightening regulations for locomotives and water-borne vessels are presenting potential new opportunities for additional demand growth. As a result of these factors, Fitch expects TEN's revenue stream to become increasingly diversified over the next several years. Fitch also expects the company's revenue to grow at a rate in excess of global light vehicle production as its product penetration increases and as it transitions into the new market segments. In addition to emission control products, new technologies in the company's Ride Performance division, including active and lower-cost semi-active suspension systems, will also contribute to increased revenues and margins.
Based on increasing demand from the commercial vehicle and off-highway segments, the proportion of TEN's original equipment revenue tied to those segments could more than double within five years, to about 30% from 13% in 2012. This growth, on top of the expected rise in global light vehicle production, is expected to result in a substantial increase in the company's original equipment revenue over the intermediate term. Combined with the permanent changes to the company's cost structure, including new or expanded manufacturing facilities in a number of low-cost countries and cost reduction activities currently underway in Europe, as well as the higher margins that the commercial and off-highway business typically generates, Fitch expects higher business levels to support margins at or above current levels over the intermediate term. Fitch's calculated EBITDA margin was 8.8% in 2012, but excluding substrate revenues, which are largely passed through to customers with only a small markup, Fitch estimates TEN's EBITDA margin would have been about 11% for the year.
Fitch expects TEN's credit profile to strengthen over the intermediate term on higher business levels and continued discipline on controllable costs. Fitch projects that EBITDA gross leverage will show a further modest decline during 2013, potentially to around 1.5x, and is likely to decline further over the next couple of years. TEN's management has stated that the company is targeting net leverage of 1.0x in order to provide sufficient financial flexibility in the case of a downturn. Fitch views this low leverage target positively, as it suggests that leverage reduction will remain a top priority for the company over the intermediate term. TEN's actual net leverage at Dec. 31, 2012, was 1.5x. Fitch notes that the company has the flexibility to use excess free cash flow to prepay amounts outstanding on the secured Term Loan A without penalty.
The greatest risk to TEN's credit profile in the near term is the potential for a decline in global vehicle production driven by a slowing global economy. This risk is offset somewhat by the company's increasingly diverse customer base, lowered cost structure, and tightening global emissions regulations, which will drive the market for emission control solutions regardless of global economic conditions. This is especially true for commercial and off-road vehicles, which will continue to increase TEN's installed penetration rates over the intermediate term. In addition, the company's lack of meaningful debt maturities until 2017 further mitigates near-term liquidity risk in a weakened demand environment. Rising vehicle fuel prices also present a risk in that they could result in a decline in overall vehicle demand, as well as a shift in demand toward smaller vehicles that are less profitable for TEN. Volatile raw material costs are also a risk, although TEN mitigates this risk by passing along a substantial portion of the change in its material costs to its original equipment customers. Offsetting increased material costs in the aftermarket business is more challenging, however.
In 2012, TEN's credit profile strengthened modestly on continued improvements in the company's operating performance and a slight reduction in debt. As of Dec. 31, 2012, TEN's EBITDA leverage (as calculated by Fitch) stood at 1.8 times (x), down from 2.0x at year-end 2011, while total debt of $1.18 billion was down from $1.22 billion. Funds from operations (FFO) adjusted leverage was 2.7x at year-end 2012, down from 3.2x at year-end 2011. Free cash flow grew substantially in 2012, to $109 million from $32 million in 2011, despite a $43 million increase in capital spending to $256 million. Over the intermediate term, Fitch expects free cash flow to remain positive, but it will be constrained somewhat by relatively high capital spending tied to growing production levels and cash costs tied to the company's European cost reduction program. On the latter topic, Fitch estimates that cash costs to implement the European cost reduction program could total roughly $90 million over the course of 2013 and 2014.
Although revenue increased only 2.2% in 2012, to $7.4 billion, margins grew on improved manufacturing efficiencies and cost controls. Fitch's calculated EBITDA margin was 8.8% in 2012 versus 8.5% in 2011, and the free cash flow margin grew to 1.5% from 0.4%. Overall liquidity remained relatively strong, with $223 million in cash and marketable securities and $710 million in availability on the company's secured revolver, while short-term debt maturities (including current maturities of long-term debt) totaled $113 million. Long-term debt maturities are comparatively light until 2017, when the final $125 million payment on the company's Term Loan A and any outstanding revolver borrowings come due.
The funded status of TEN's global pension plans improved slightly in 2012, with the plans' funded status increasing to 68% at year-end 2012 from 67% at year-end 2011. However, in the U.S., TEN's plans were only 60% funded at Dec. 31, 2012, up from 58% at the end of 2011. As with many corporate plans, the continued low funded status was primarily due to historically low long-term interest rates, with TEN using a 4.1% discount rate to value its projected benefit obligation in 2012, down from 4.8% in 2011. On a dollar basis, however, TEN's global plans were only underfunded by $285 million ($186 million in the U.S.), which Fitch believes is manageable, given the company's liquidity position and free cash flow prospects. TEN has estimated that required cash contributions to its global pension plans will be $59 million in 2013, up from $48 million in 2012.
TEN's secured revolver and secured Term Loan A are both rated one-notch above the company's IDR to reflect their substantial collateral coverage, which includes virtually all of the company's U.S. assets and up to 66% of its first-tier foreign subsidiaries. As detailed in Fitch's criteria report, 'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers', 'BBB-' is the highest rating that may be assigned to an issuance or facility of an issuer with an IDR of 'BB+' or lower. TEN's senior unsecured notes are rated one notch below the company's IDR to reflect the substantial amount of secured debt in the company's capital structure. Assuming a fully-drawn revolver, about 60% of TEN's long-term debt would be secured, reducing potential recoveries for unsecured creditors.
Positive: Further developments that may, individually or collectively, lead to a positive rating action include:
--A continued decline in leverage to the low 1x level;
--Further growth in the company's free cash flow and free cash flow margin;
--Maintaining a value-added margin above 10%;
--Improvement in the funded status of the company's pension plans.
Negative: Further developments that may, individually or collectively, lead to a negative rating action include:
--A severe decline in global vehicle production that leads to reduced demand for TEN's products;
--A debt-financed acquisition that weakens credit metrics for a prolonged period;
--Shareholder-friendly actions that result in a significant increase in leverage or decline in liquidity;
--A reversal in the company's focus on reducing operating leverage.
Fitch has taken the following rating actions on TEN with a Stable Rating Outlook:
--Issuer Default Rating (IDR) upgraded to 'BB+' from 'BB';
--Secured Term Loan A rating affirmed at 'BBB-';
--Secured revolving credit facility rating affirmed at 'BBB-';
--Senior unsecured notes rating upgraded to 'BB' from 'BB-'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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);
--2013 Outlook: U.S. Auto Manufacturers and Suppliers (Dec. 17, 2012).
Applicable Criteria and Related Research
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Evaluating Corporate Governance
2013 Outlook: U.S. Auto Manufacturers and Suppliers