CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed its ratings for Snap-on Inc. (NYSE: SNA), including the company's Issuer Default Rating (IDR) at 'A-'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings for Snap-on reflect the company's strong brand recognition among its customers, conservative financial policies, consistent free cash flow (FCF) generation and solid liquidity position. Risks include sensitivity to business cycles and Snap-on's dependence on the auto repair market.
The Stable Outlook reflects Fitch's expectation that the company will continue to grow overall sales and maintain or improve current margins as strong sales in the U.S. and certain emerging markets are partially countered by continued weakness in Europe and lower sales to the U.S. military.
Snap-on borrows all public debt at the parent level which funds its Financial Services operations directly. The company allocates debt internally between its manufacturing and finance operations. Snap-on manages leverage at the Financial Services level at a debt to equity ratio of 5x and intends to manage at this level over the near to intermediate term. Both businesses are well capitalized on this basis.
Leverage at the manufacturing level (with Financial Services at equity) declined to approximately 0.2x for the latest 12 months (LTM) ended June 29, 2013 from 0.3x at the end of 2012 and 0.6x at the end of 2011. Fitch expects manufacturing leverage will continue to decline gradually as moderate growth at Financial Services allows it to absorb a higher proportion of allocated debt. On a consolidated basis, leverage improved to 1.5x for the LTM period ending June 29, 2013 from 1.6x at year-end 2012 and 1.8x at the end of 2011. Fitch expects leverage to remain in the 1.25x-1.75x range during the next 12-18 months.
Interest coverage at the manufacturing level also remains solid at 10.2x for the June 29, 2013 LTM period compared with 9.6x at year-end 2012 and 8x at year-end 2011. Fitch expects the interest coverage ratio will be in the 10x-11x range during the next 12-18 months.
LIQUIDITY AND CASH FLOW
Snap-on maintains solid liquidity with cash of $170.9 million at the manufacturing level ($3.8 million was held at the Financial Services segment) as of June 29, 2013 and no borrowings under its $500 million revolving credit facility that matures in 2016. The company also has an unused $200 million Asset-Backed Securitization Facility. Fitch expects that the company will have continued access to these credit facilities as Snap-on has sufficient cushion under its financial covenants. The company's debt maturities are well laddered, with no major debt maturities until March 2014, when $100 million of senior notes mature.
Consolidated FCF remains robust, totaling $201.1 million during the LTM period ending June 29, 2013 compared with $168.4 million in 2012. Fitch expects Snap-on will generate FCF of $150 million-$200 million during 2013.
Fitch expects liquidity and FCF will be used for acquisition opportunities, fund pension liabilities and perhaps increase dividend payments. Fitch also expects management will continue to make moderate share repurchases, primarily to offset dilution from stock awards. During the first half of the year, the company repurchased 725,000 shares for $62.1 million. This compares to $78.1 million of share repurchases during 2012 and $37.4 million during 2011. As of June 29, 2013, the company had remaining availability to repurchase up to an additional $183.1 million in common stock under its current authorizations.
Sales at Snap-on's manufacturing operations improved slightly during the first half of 2013 as strong sales in the U.S. and certain emerging markets were somewhat offset by continued weakness in Europe and lower sales to the U.S. military. Organic sales during the first half of 2013 improved 2.3% year-over-year, led by a 7.1% organic sales growth in the company's Repair Systems and Information Group and 5.4% organic growth in its Snap-on Tools Group. Organic sales in the Commercial and Industrial Group declined 5.8% during the first half of the year, reflecting a double digit decline in sales to the U.S. military. Sales also remained sluggish in Europe with Snap-on's hand tools business in this region declining in the high-single-digits percentage during the first half of 2013. (Sales in Europe represented approximately 21% of total external sales in 2012.) The company reported operating margins from its manufacturing operations of 15.4% during the second quarter of 2013, a 120 basis point improvement from the same period last year.
Fitch projects manufacturing sales will increase in the low to mid-single digits in 2013. Fitch also expects Snap-on will maintain or slightly improve manufacturing operating margins in the near term due to slightly higher sales volumes. Snap-on should also benefit from a larger mix of higher margin diagnostic and repair information related sales.
DEPENDENCE ON AUTO REPAIR MARKET AND GROWTH STRATEGY
The primary risk facing Snap-on is the company's dependence on the auto repair market, and the tendency for car owners to delay repairs and maintenance during an economic downturn. As was the case in 2008 and 2009, auto repair spending fell despite the higher average age of cars on the road. Subsequently, tool sales dropped off, especially for big ticket diagnostic and undercar equipment. Management estimates that about 70% of its 2012 revenues were generated from the vehicle service market.
Snap-on seeks to diversify its operations by extending its presence into critical industries outside the automotive repair segment. The company has leveraged its technology across the organization to develop new products for the aerospace, military, oil and gas, natural resources and power generation industries. Snap-on faces strong competition from well-established industry players as it expands into these markets. This concern is somewhat mitigated by Snap-on's reputation for high quality products.
The company's strategy also includes expansion into the international auto repair market where there are substantial growth opportunities. While Snap-on has had success with its established business model in North America, the United Kingdom and Australia where franchisees sell directly to technicians, a similar dealer network does not exist in emerging markets. These markets are generally served through distributors and direct sales staff. However, Fitch believes Snap-on's sales and support network in China, an underdeveloped market, will provide a solid base for future growth.
FINANCIAL SERVICES SEGMENT
Snap-on provides customer financing through its Financial Services businesses. Financial Services provides these programs to customers for the purchase of Snap-on tools, tool storage and diagnostic products through its extended credit and leasing programs. The businesses also provide franchisee financing. Financial Services provides strategic advantages to Snap-on in terms of attracting and retaining customers by structuring flexible payment terms and the continuity of collections in person by the franchisees.
Snap-on's decision to restrict Financial Services' activity to captive finance mitigates some risks associated with managing a finance subsidiary. In the intermediate term, Fitch does not expect Snap-on to expand its financial services operations beyond its captive finance. Since the finance JV with CIT was terminated in mid-2009, the company's on-balance sheet finance portfolio has grown to approximately $1.1 billion as of June 29, 2013. Fitch estimates finance receivables on balance sheet will remain around these levels for the next several years, as asset growth will likely slow to mirror growth in domestic sales. Future borrowings are expected to be minimal due to slower growth in the portfolio, together with normal profitability.
Snap-on manages leverage at the Financial Services level at a debt to equity ratio of 5x. Fitch believes leverage is appropriate at its current level based on the quality of receivables financed and support from the manufacturing operations. This leverage target is consistent with other captive finance subsidiaries rated by Fitch.
Although Financial Services primarily finances sub-prime borrowers, it clearly benefits from a deep knowledge of its client base and the products being financed. Snap-on's ability to provide financing to these borrowers is based upon its unique but well-managed business model wherein franchisees see the customer on a weekly basis. Additionally, the company employs consistent underwriting standards and prudent risk management. Asset quality metrics are adequate and remained within acceptable levels, even during the economic downturn.
Fitch currently does not expect positive rating actions will be taken in the next 12 months. However, a positive rating action may be considered if the company's performance significantly exceeds Fitch's expectations, including EBITDA margins in excess of 20%, FCF margins in the high single-digit range and consolidated leverage consistently below 1x.
On the other hand, Fitch could consider taking a negative rating action if market fundamentals deteriorate, resulting in a weakening of the company's credit profile (perhaps similar to 2009 levels) for an extended period. A negative rating action would also be considered if the Financial Services operation experiences a substantial deterioration in asset quality and higher leverage levels that require meaningful support from the manufacturing operations.
Fitch has affirmed the following ratings for Snap-on with a Stable Outlook:
--Issuer Default Rating (IDR) at 'A-';
--Senior unsecured debt at 'A-';
--Unsecured revolving credit facility at 'A-';
--Short-term IDR at 'F2'; and
--Commercial paper at 'F2'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Global Financial Institutions Rating Criteria' (Aug. 10, 2012);
--'Finance and Leasing Companies Criteria' (Dec. 11, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Global Financial Institutions Rating Criteria
Finance and Leasing Companies Criteria