Fitch Affirms BorgWarner's IDR at 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed BorgWarner Inc.'s (BWA) Long-Term Issuer Default Rating (IDR) at 'BBB+' and Short-Term IDR at 'F2'. Fitch has also affirmed BWA's unsecured credit facility and senior unsecured notes ratings at 'BBB+' and commercial paper (CP) program rating at 'F2'. A complete list of the ratings follows at the end of this release. Fitch's ratings apply to a $1 billion unsecured revolving credit facility, $1.7 billion (par value) in senior unsecured notes and a $1 billion CP program. The Rating Outlook for BWA is Stable.

KEY RATING DRIVERS

BWA's ratings are supported by the company's strong competitive position as a key global supplier of automotive engine and drivetrain components, significant free cash flow (FCF) generation potential, solid liquidity position and low leverage. BWA managed through the last economic downturn relatively well, and with a product portfolio largely focused on technologies that enhance fuel efficiency, such as turbochargers and dual-clutch transmission components, revenue growth is likely to outpace global automotive production over the intermediate term. In addition, efficient capacity utilization and a focus on cost control have resulted in profitability that is high for the industry, contributing to its consistent FCF and providing the company with significant financial flexibility.

Fitch's concerns include BWA's ongoing interest in acquisitions, which could result in higher leverage, and an increased focus on shareholder-friendly activities. BWA recently announced a $1 billion three-year share repurchase program, representing a meaningful increase in share repurchase activity following at total of $661 million in share repurchases in the 2012 through 2014 period. The company also reinstated a dividend in mid-2013 and paid a total of $116 million in dividends in 2014. Fitch's share repurchase concerns are mitigated somewhat by the company's consistently positive FCF generation. FCF totaled $102 million in 2014 even after the company increased capital spending by $145 million to support its substantial book of future business.

An additional rating concern is the large proportion of BWA's consolidated cash that is located outside the U.S. At year-end 2014, only $1.8 million of the company's cash balance was in the U.S. This increased to $423 million at March 31, 2015, largely as a result of incremental debt that the company issued during the first quarter. Although the company needs to maintain significant cash balances outside the U.S. to fund its sizeable non-U.S. operations (76% of its revenue in 2014 was generated outside the U.S.) and to potentially fund overseas acquisitions, leverage could continue to rise if it chooses to fund its shareholder-friendly activities with debt rather than with repatriated cash. BWA had $461 million in CP outstanding at year-end 2014, some of which was used to fund shareholder-friendly activities during the year. It later termed out the CP debt with its first quarter notes issuance. Fitch expects BWA's leverage will remain consistent with its ratings over the intermediate term, but there is a risk that it could rise if the company continues to borrow to fund its shareholder activities. An increase in EBITDA leverage (debt/Fitch-calculated EBITDA) above 1.5x for a prolonged period could result in a negative rating action.

Fitch expects BWA to continue seeking opportunities to grow its business through targeted acquisitions. Management has laid out a goal of doubling the company's revenue between 2012 and 2020 to about $15 billion, and achieving this target will likely require the company to make acquisitions over the next several years. BWA maintains a disciplined acquisition selection process, generally using acquisitions to obtain specific technologies that complement its existing products. The company's methodical approach to acquisitions often identifies potential targets well before they are available. Fitch expects that most acquisitions will be moderately sized, likely under $500 million, and will be funded with cash on hand, temporary revolver borrowings or CP, although it is possible the company could engage in some incremental long-term issuance to support a larger acquisition. Overall, although BWA's acquisitive nature does present some credit risk, Fitch believes the company has the ability to undertake moderately sized acquisitions while keeping its overall credit profile consistent with its 'BBB+' IDR.

BWA's liquidity position at March 31, 2015, was higher than normal, as cash from incremental debt issued during the first quarter remained on its balance sheet. BWA ended the quarter with total consolidated cash and cash equivalents of $1.0 billion, which, as noted above, included $423 million in the U.S. and $612 million outside the U.S. The company also had full availability on its $1 billion revolver, for a total liquidity position of $2.0 billion. BWA had no CP borrowings outstanding at March 31, 2015, but any CP issuance would reduce the revolver's availability by a like amount. Short-term debt and current maturities of long-term debt at March 31, 2015 totaled only $108 million. Going forward, Fitch expects BWA's liquidity position and FCF to provide the company with substantial financial flexibility through the economic cycle.

BWA's credit profile remains strong for the auto supply industry, despite the recent increase in debt. The company's EBITDA margin in the last 12 months (LTM) ended March 31, 2015 was a very strong 17.2% and the company produced $1.4 billion in EBITDA. EBITDA leverage (debt/Fitch-calculated EBITDA) at March 31, 2015 was 1.3x, as debt totaled $1.8 billion. This represented an increase in leverage from year-end 2014, when the company's debt totaled $1.3 billion and EBITDA leverage was 0.9x. During the first quarter, the company issued $1 billion in senior unsecured notes and fully repaid $461 million in CP that was outstanding at year-end 2014. Funds from operations (FFO) adjusted leverage was 2.1x at March 31, 2015. Long-term debt maturities are relatively light over the intermediate term, although the company has $150 million in senior unsecured notes that mature in November 2016. In 2014, BWA extended the maturity date of its unsecured revolver to 2019. Fitch expects leverage to remain relatively low over the intermediate term, although it could rise temporarily following an acquisition or if the company funds shareholder-friendly activities with CP.

BWA manages its leverage based on a net debt to capital ratio target range of 15% to 30%. At year-end 2014, BWA's net debt to capital ratio was below the target range at only 12.8%. However, following the incremental debt issued in the first quarter of 2015, the company's net debt to capital ratio rose to 18.4% at March 31, 2015. Over the intermediate term, Fitch expects the company's net debt to capital ratio will rise into the low- to mid-20% range, largely as a result of cash balances declining back toward historical levels in the $700 million to $800 million range, either as a result of acquisitions or share repurchases. Fitch expects the company's EBITDA leverage to remain relatively stable as the company's net debt to capital ratio nears the midpoint of the target range.

FCF in the LTM ended March 31, 2015 was $71 million, leading to a FCF margin of 0.9%. Included in this figure was $117 million in dividend payments. FCF also included the effect of higher-than-normal capital spending of $577 million, equal to 7.0% of revenue in the period, as the company continued to invest in new plants and plant expansions to support its growing book of business. BWA expects capital spending to fall back toward its target level of 6% of revenue after 2015. Looking ahead, Fitch expects BWA to produce solidly positive FCF over the intermediate term. Dividends will likely rise over time, but this will be offset somewhat by capital spending declining relative to revenue (although it may rise in absolute terms). Over the intermediate term, Fitch expects the company's FCF margin, including dividends, will rise toward the mid-single-digit range.

BWA's pension plans remained relatively well funded at year-end 2014. As of Dec. 31, 2014, the company's U.S. plans, which have been closed to new entrants since 1999, were 87% funded, with an underfunded status of only $41 million. The company also sponsors defined benefit plans in certain countries outside the U.S., some of which are generally unfunded. BWA did not make any contributions to its U.S. plans in 2014, but it contributed $53 million to its non-U.S. plans during the year. The company's non-U.S. plans were 75% funded at year-end 2014, with an underfunded position of $132 million. The company expects to contribute between $15 million and $25 million to its global plans in 2015, including $9.9 million of contractually-required contributions. The remainder of the planned contributions will be voluntary. Given the relatively low underfunded level of BWA's pension plans, particularly the U.S. plan, Fitch does not currently view BWA's pension plans as a meaningful credit risk.

KEY ASSUMPTIONS

--Global economic conditions continue to improve at a modest pace over the intermediate term, leading to low- to mid-single digit growth in global auto production.

--In the near term, foreign exchange pressure from the strong U.S. dollar more than offsets revenue growth from higher business levels.

--The company makes several small- to medium-sized acquisitions over the next several years, funding a portion of the purchases with temporary debt increases.

--Maturing debt obligations are refinanced.

--Capital spending is elevated in 2015, and then falls to more normalized levels in subsequent years.

--Dividends grow on an annual basis.

--Free cash flow is used to fund acquisitions or share repurchases.

--The company maintains about $700 million in cash on its balance sheet over the intermediate term.

RATING SENSITIVITIES

Positive: Given BWA's 'BBB+' IDR, a near-term upgrade of the company's ratings is unlikely. Typically, the inherent cyclicality and potential financial pressures of the auto supply industry result in a soft cap on IDRs at the 'BBB+' level, although in rare cases a supplier with a very strong business profile and unusually strong credit protection metrics could be considered for the 'A' category.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--An unexpected sharp drop in global auto production;

--An increase in leverage to above 1.5x for an extended period;

--A decline in the company's EBITDA margin to below 12%;

--A significant increase in long-term debt to support shareholder-friendly actions.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

--Long-Term IDR at 'BBB+';

--Short-Term IDR at 'F2';

--Unsecured revolving credit facility at 'BBB+';

--Senior unsecured notes at 'BBB+';

--CP program at 'F2'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985937

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Stephen Brown
Senior Director
+1-312-368-3139
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Committee Chairperson
Bill Densmore
Senior Director
+1-312-368-3125
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Stephen Brown
Senior Director
+1-312-368-3139
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Committee Chairperson
Bill Densmore
Senior Director
+1-312-368-3125
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com