CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 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, driven by a moderately stronger U.S. economy, strength in certain emerging markets as well as stabilizing conditions in Europe and at least steady sales to the U.S. military.
Snap-on employs a conservative financial strategy and is committed to a strong investment grade rating. The company generates robust FCF, totaling $240.5 million during the latest-twelve-months (LTM) ending June 28, 2014 compared with $230 million during 2013 and $168.4 million during 2012. Fitch expects Snap-on will generate FCF of about 6% of revenues during both 2014 and 2015.
The company remains disciplined in the uses of its cash and cash flow and Fitch expects this to continue. Fitch expects FCF will be used to fund acquisitions, fund pension liabilities and perhaps increase dividend payments. The company completed two acquisitions totaling $79.8 million during the past 18 months. Both of these acquisitions were funded primarily with cash on hand. In November 2013, Snap-on raised its quarterly dividends by 15.8% following an 11.8% increase in November 2012.
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 550,000 shares for $62.5 million. This compares to $82.6 million of share repurchases during 2013 and $78.1 million during 2012. As of June 28, 2014, the company had remaining availability to repurchase up to an additional $198.7 million of common stock under its current authorizations.
Snap-on borrows all public debt at the parent level, which funds its Financial Services operations directly. The company allocates debt internally between its operating and finance segments. 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. With the growth of its finance operations, substantially all of the company's debt is now fully allocated to the Financial Services segment. (Fitch allocates short-term debt to the operating segment.) Both businesses are well capitalized on this basis.
Snap-on maintains solid liquidity with cash of $113.4 million at the operating segment ($2.4 million was held at the financial services segment) as of June 28, 2014 and roughly $670 million of availability under its $700 million commercial paper (CP) program that is backed by the company's $700 million revolver that matures in September 2018.
In September 2013, the company increased the revolver from $500 million to $700 million following its decision not to renew its $200 million Accounts Receivable Securitization facility. As of June 28, 2014, there were no borrowings under the revolver. Fitch expects that the company will have continued access to the revolver as Snap-on has sufficient cushion under the facility's financial covenants.
Snap-on repaid $100 million of senior notes that matured in March 2014 with cash on hand and CP borrowings, which were subsequently repaid prior to the end of the first quarter. The company's next debt maturity is in January 2017, when $150 million of senior notes are due.
Leverage as measured by debt to EBITDA at the manufacturing level (excluding Financial Services EBITDA) was 0.08x for the LTM period ending June 28, 2014 compared with .02x at the end of 2013 and 0.3x at the conclusion of 2012. Fitch expects manufacturing leverage will remain at low levels as substantially all of the company's debt is fully allocated to the Financial Services segment.
On a consolidated basis, leverage improved to 1.2x for the LTM period ending June 28, 2014 compared with 1.4x at year-end 2013 and 1.6x at year-end 2012. Fitch expects consolidated leverage will remain in the 1x - 1.25x over the next 12-24 months.
Interest coverage at the manufacturing level also remains solid at 11.3x for the June 28, 2014 LTM period compared with 10.5x during 2013 and 9.6x during 2012. Fitch expects the interest coverage ratio will be above 12x during the next 12-24 months.
Sales at Snap-on's manufacturing operations improved modestly during the first half of 2014, with organic sales growth of 5.8% and contributions from acquisitions resulting in overall net sales increasing 7.2% compared with the same period last year. The company's European-based hand tools business, which has been sluggish during the past few years, reported a mid-single digit sales increase during the first half of 2014. Sales to the U.S. military also somewhat stabilized during the second quarter of 2014.
Operating margins before financial services improved 110 bps to 16.1% during the first half of 2014 compared with 15% during the first half of 2013.
Fitch projects manufacturing sales will increase mid-single digits in 2014, driven by organic sales growth and contributions from acquisitions. Fitch also expects Snap-on will slightly improve manufacturing operating margins in the near term due to higher sales volumes as well as the impact from its rapid continuous improvement initiatives. Snap-on should also benefit from a richer mix of higher margin diagnostic and repair information related sales.
DEPENDENCE ON AUTO REPAIR MARKET
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 2013 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.
Snap-on has supplemented its organic growth with bolt-on acquisitions. The company spent $41.6 million for the acquisition of Pro-Cut International, Inc. (Pro-Cut) in May 2014 and $38.2 million for the purchase of Challenger Lifts, Inc. (Challenger) in May 2013. Pro-Cut designs, manufactures and distributes on-car brake lathes, related equipment and accessories used in brake servicing by automotive repair facilities. Challenger designs, manufactures and distributes a comprehensive line of vehicle lifts and accessories to a diverse customer base in the automotive repair sector.
Both of these acquisitions were financed primarily with cash on hand. These two acquisitions complemented and increased Snap-on's existing undercar equipment offerings, broadened its established capabilities in serving vehicle repair facilities, and expanded its presence with repair shop owners and managers. Fitch expects Snap-on will continue to look for acquisition opportunities, particularly bolt-on acquisitions that would allow the company to expand into emerging markets, critical industries and enhance its capabilities in serving vehicle repair facilities.
FINANCIAL SERVICES SEGMENT
Snap-on provides customer financing through its Financial Services businesses. This segment provides various financing 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.
Since the financial services JV with CIT was terminated in mid-2009, the company's on-balance sheet U.S. finance portfolio has grown to approximately $1.1 billion as of June 28, 2014. Fitch estimates U.S. finance receivables will grow at a higher rate compared with domestic tool sales in the intermediate term and then perhaps mirror growth in domestic sales thereafter. Snap-on's decision to restrict the financial services segment's 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, which continues to exhibit higher profitability than its captive finance peers given the relatively subprime nature of its portfolio.
Future borrowings are expected to be minimal as portfolio growth in the intermediate term will likely be funded with cash on hand and FCF. 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 also considered somewhat conservative compared with other captive finance subsidiaries rated by Fitch.
Although the financial services segment primarily finances subprime 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, although not quite as strong as peers, are adequate and continue to improve. Further, these metrics have been and continue to remain within acceptable levels since 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-digits and consolidated leverage regularly 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, including debt to EBITDA levels above 2x and interest coverage below 8x) 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' (May 28, 2014);
--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);
--'Rating FI Subsidiaries and Holding Companies' (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
Rating FI Subsidiaries and Holding Companies
Finance and Leasing Companies Criteria