NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an initial Issuer Default Rating (IDR) of 'BBB' to The Timken Company (TKR). Fitch has also assigned initial ratings to Timken's senior unsecured bank credit facility and senior unsecured notes. Fitch expects to assign a rating of 'BBB' to Timken's planned issuance of approximately $300 million of ten year senior unsecured notes. The notes are being offered under Rule 144A. A portion of the proceeds will be used to repay $250 million of 6% senior unsecured notes due Sept. 15, 2014. Remaining proceeds will be available for general corporate purposes. The Rating Outlook is Stable. A detailed list of ratings follows at the end of this release.
KEY RATING DRIVERS
Rating strengths include Timken's well established position in selected industrial bearings markets, technological capabilities, broad customer base, solid credit metrics for the rating, solid liquidity, and well-funded pension plans. Significant aftermarket revenue generates attractive margins and mitigates the impact of cyclical end-markets. Timken's business portfolio is aligned with industrial markets that offer attractive aftermarket revenue and margins and steadier results after excluding TimkenSteel.
The ratings consider Timken's spin-off of TimkenSteel Corporation at the end of June 2014. The transaction reduced Timken's exposure to the competitive and highly cyclical steel industry and allows the company to focus on its core industrial bearings business and related power transmission markets. More than 40% of revenue is outside the U.S. following the spin-off.
TimkenSteel represented approximately one-third of TKR's revenue prior to the spin-off and between one-fourth and one-third of operating profit. Timken's remaining businesses are also cyclical but are somewhat more stable than the steel business which helps to mitigate the impact of an expected increase in leverage on the company's financial strength and flexibility.
Timken retained most of its existing debt at the spin, but pre-spin debt was relatively low, and pro forma leverage remains modest before considering Timken's plans for debt-funded cash deployment through 2015. The ratings incorporate Timken's plan to maintain leverage at a higher level than in the past. Fitch estimates total adjusted debt/EBITDAR will be in a range near 2.25x by the end of 2015. Proceeds from the company's planned increase in debt would be used for a combination of share repurchases and acquisitions, as well as the repayment of debt from the notes issuance described earlier in this release.
Rating concerns include the negative impact on credit measures from anticipated cash deployment and debt issuance, weak margins and slow defense spending in the aerospace segment, and normal risks associated with expanding and diversifying into adjacent industrial markets. Other concerns include execution risk related to potential acquisitions and one-time separation costs related to the steel spin, although most of the separation costs had been incurred by the end of the second quarter of 2014. Annualized savings from restructuring are estimated at $20 million.
The Stable Rating Outlook recognizes Timken's financial flexibility as it deploys cash for share repurchases and acquisitions and expands beyond its traditional bearings business. Over the long term, an effective transition to higher margins and increased diversification would improve the company's operating profile. Fitch believes Timken will balance discretionary spending and financial results that would keep leverage within levels that support the 'BBB' ratings.
Future acquisitions likely would be used to leverage Timken's existing capabilities in tapered roller bearings across the broader industrial bearings market and expand into adjacent systems and services in the drive train market. Timken has increased its presence in these markets during the past several years while it has also gradually exited certain low-margin automotive business. These actions, together with the steel spin-off, could support higher margins due to high technology content and potential aftermarket revenue.
Fitch expects share repurchases and dividends will be substantial in the near term. Timken's internal share repurchase authorization would allow it to repurchase more than $500 million at the current share price, much of which could be completed in the next 18 months. The company expects to maintain the existing dividend in dollar terms which effectively increases the payout as a proportion of earnings following the steel spin. Initially, the payout may be near or above the high end of Timken's target range of 25%-35%, but should decline to within the range over time as sales and margins improve.
Fitch estimates free cash flow after dividends (FCF) in 2014 will approach $150 million compared to $17 million in 2013 which included the steel business. FCF includes the impact of lower pension contributions in 2014, a flat dividend payout, and lower capital expenditures relative to sales. Timken plans to maintain capital expenditures near 4% of sales or lower compared to around 6% or higher in the previous two years which included the steel business. FCF could benefit if Timken is able to realize a gradual improvement in working capital requirements.
Pension contributions to global plans could decline to $20 million compared to $121 million contributed in 2013. Timken estimates aggregate plans, excluding steel, are slightly overfunded. Gross pension liabilities are substantial at approximately $2 billion, and the net funded status is sensitive to asset returns and discount rates. However, the spin-off of the steel business reduced gross liabilities by roughly one-third, and Timken plans to gradually de-risk the remaining plans.
Liquidity at June 30, 2014 included $295 million of unrestricted cash and cash equivalents, plus availability under a $500 million revolving credit facility that matures in May 2016. Approximately $190 million of the company's cash was located overseas. Timken has implemented a strategy to repatriate approximately $365 million over several years, including $123 million repatriated in the first quarter of 2014. Timken also has a $100 million receivables securitization facility of which $56.6 million was available and $40 million was utilized at June 30, 2014. The bank facility has financial covenants including maximum consolidated leverage of 3.25x (1.06x at June 30, 2014) and minimum consolidated interest coverage of 4.0x (14.28x at June 30, 2014).
Liquidity at June 30, 2014 was offset by $315 million of short-term debt and current maturities of long term debt. Long-term debt due beyond one year totaled $176 million, most of which matures in 2025 or later.
Future developments that may, individually or collectively, lead to a negative rating action include:
--A decline in operating margins, or weak FCF including FCF/total adjusted debt below 5%;
--Aggressive cash deployment leading to higher-than-anticipated leverage, including total adjusted debt/EBITDAR of 2.5x - 2.75x or higher;
--Significant loss of market share.
Fitch views an upgrade as less likely than a downgrade given Timken's plan to maintain higher leverage. However, future developments that may, individually or collectively, lead to a positive rating action include:
--Increased product and geographic diversification through product development or acquisitions that reduces the company's reliance on industrial bearings;
--Strong FCF, including FCF/Total adjusted debt consistently above 10%, that would reduce reliance on debt to fund planned discretionary spending for acquisitions and share repurchases;
--Total adjusted debt/EBITDAR is consistently below 2.0x.
Fitch has assigned the following ratings:
The Timken Company
--Senior unsecured bank credit facility 'BBB';
--Senior unsecured notes 'BBB'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage