CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed its 'BBB' Issuer Default Rating (IDR) on The Timken Company (TKR). Fitch has also affirmed Timken's senior unsecured bank credit facility and senior unsecured notes at 'BBB'. TKR had $638 million of debt outstanding as of June 30, 2015. The Rating Outlook is Stable. A detailed list of ratings follows at the end of this release.
KEY RATING DRIVERS
The affirmation takes into account TKR's currently weak operating results, its recent acquisition of Carlstar Belts, ongoing sizable share repurchases and the resulting increase in financial leverage, which Fitch had expected. TKR's business weakened in 2015 due to soft end markets and the impact of the strong dollar. TKR's sales declined 4.9% in the first half of 2015 (1H15), and adjusted EBIT margin declined by around 60 basis points (bps), with weakness concentrated in the Mobile Industries segment. EBITDA declined to $487 million in the 12 months ended June 2015 from $514 million in 2014, and Fitch expects it could drop further to the mid-$400 million range for full-year 2015.
Timken completed the acquisition of the Carlstar Belts business on Sept. 1, 2015, paying $220 million in cash. Carlstar is a leading North American manufacturer of belts for industrial, commercial and consumer applications, and generated sales of $140 million in the 12 months ended June 30, 2015. The acquisition, which was financed with bank borrowings, further extends Timken's business beyond bearings and into power transmission systems. Pro forma for the acquisition, TKR's adjusted debt/EBITDAR increases to 2.1x from a reported 1.8x as of mid-2015. With a further decline in EBITDA in the second half, Fitch expects adjusted leverage could increase to around 2.2x - 2.3x at year-end 2015, assuming no debt reduction from cash flow during the second half of the year.
This is in-line with Fitch's expectations and is consistent with the company's plan to add leverage to its capital structure during 2015 and to operate with higher leverage. Going forward, Fitch expects Timken will maintain adjusted debt/EBITDAR of 2.0x - 2.5x, adjusting its share repurchases in the context of its acquisitions to maintain leverage within this range. If weakness in Timken's end markets persists, Fitch expects the company would adjust its spending on acquisitions and share repurchases in order to maintain its credit profile. However, should the business weaken further, causing adjusted leverage to move up toward 2.5x, there could be negative rating implications.
Rating strengths include Timken's well-established position in tapered roller bearings, technological capabilities, broad customer base and well-funded pension plans. Significant aftermarket revenue generates attractive margins and mitigates the impact of cyclical end markets. Rating concerns include recently weak operating results, depressed demand in certain of Timken's industrial end markets, meaningful currency risk, and the risks associated with the company's acquisition strategy.
The Mobile Industries segment accounted for 55% of sales and 37% of EBIT in 2014, and has experienced sales declines and margin pressure over the past two years. In 1H15, the Mobile Industries segment's revenue fell 10% to $782 million. The decrease was driven by lower aerospace, agriculture, and automotive demand, partially offset by growth in rail. EBIT margins were driven lower by lower volumes and currency changes and partially offset by favorable material and logistic costs, and lower SG&A costs.
The Process Industries segment accounted for 45% of sales and 63% of EBIT in 2014, and has held up relatively well, generating sales growth in 2014 and 1H15, with healthier margins. The higher volume in 1H15 was primarily due to higher demand in the wind energy and military marine markets. EBIT margins were lower in 2015 due to an unfavorable sales mix and foreign exchange rates.
Fitch believes TKR's sales and margins will begin to stabilize during 2016. Fitch estimates free cash flow (FCF) after dividends will track at or above $100 million in 2015 and beyond, reflecting capex/revenues of around 4% and a steady dividend payout. Pension contributions are manageable, and Timken estimates its aggregate plans are slightly overfunded.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-- Sales decline by around 6% in 2015, including the impact of the Carlstar acquisition, and stabilize and begin to recover in 2016.
-- EBIT margins narrow to around 11% in 2015, and recover gradually thereafter.
-- FCF tracks at or above $100 million annually.
-- Adjusted debt/EBITDAR remains near the middle of Fitch's expected 2x - 2.5x range.
RATING SENSITIVITIES
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 above 2.5x;
-- 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 reduce 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 consistently below 2x.
LIQUIDITY
As of June 30, 2015, total liquidity was $701 million, consisting of $237 million in cash and cash equivalents and $464 million in unused credit facilities, including cash held at international subsidiaries. Approximately $182 million, or 77% of TKR's cash, was held outside of the United States and dominated in non-USD currencies. Liquidity is also supported by a $100 million accounts receivable securitization facility, which was fully drawn (limited by an $82 million borrowing base).
FULL LIST OF RATING ACTIONS
Fitch affirms its ratings on The Timken Company as follows:
-- IDR at 'BBB';
-- Senior unsecured bank credit facility at 'BBB';
-- Senior unsecured notes at 'BBB'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Sept. 4, 2015
Additional information is available on www.fitchratings.com.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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