CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned 'A'/'F1' Long- and Short-Term Issuer Default Ratings (IDRs) to Deere & Company (Deere) and John Deere Capital Corporation (JDCC). Fitch has also assigned debt ratings for Deere and JDCC, including those of certain JDCC subsidiaries. The Rating Outlook is Stable. Approximately $31 billion of Deere's consolidated debt is covered by the ratings.
Fitch's ratings and financial measures for Deere's equipment operations (Deere Equipment) consider the company's Financial Services operations on an equity basis. The ratings for JDCC incorporate support from Deere.
A full rating list appears at the end of this release.
KEY RATING DRIVERS - Deere Equipment
The ratings for Deere incorporate Fitch's expectation that the company will maintain a strong financial profile over the long term despite near term weakness in its agricultural and construction equipment markets that are contributing to higher leverage and reduced free cash flow (FCF). Fitch expects the company will reduce discretionary spending for share repurchases and take actions to reduce its cost structure to support margins at lower sales volumes and that credit metrics will recover when the current cycle reverses. Potential support required from Deere Equipment for Financial Services represents a risk, but is viewed by Fitch as unlikely.
The current downturn in Deere's agricultural equipment market follows a cyclical peak in 2013 and is the most severe since 1979-1986 as measured by the cumulative decline in industry sales and the length of the downturn. There are indications that demand could begin to stabilize sometime in 2017, but the timing of a meaningful recovery is uncertain and could be delayed by low crop prices, net cash farm income which could decline for a fourth consecutive year in 2016, weak farmer sentiment, and high levels of used equipment. U.S. farm balance sheets are relatively strong but concerns have been increasing about agricultural credit conditions and declines in the value of farmland that have occurred since early 2014. Deere's results are also being negatively affected by low energy prices which reduce demand for construction equipment.
Rating strengths include Deere's position as the largest U.S. manufacturer of agricultural equipment with a broad product line, particularly in the large equipment market. Revenue is concentrated in developed markets but is growing in emerging markets as farmers look to increase production and invest in larger, mechanized equipment. Deere also has a leading share in forestry equipment in North America. The company's market positions in turf and construction equipment are competitive, but it has a smaller share than some other large competitors in these markets.
Fitch expects Deere's well-established position in precision agriculture should support future performance as the industry becomes increasingly reliant on digital technology. Technological applications are also relevant to the construction, forestry and turf markets. In precision agriculture, Deere uses a combination of acquisitions and agreements to expand its presence in digital applications. Fitch also recognizes competitive risks from competitors in Deere's agricultural markets as well as other providers of data services and analytics.
Fitch expects Deere Equipment's leverage and other credit metrics will be weak compared to mid-cycle levels until demand improves. Debt/EBITDA was 2x at July 31, 2016 and Fitch estimates it could increase to approximately 2.3x in the near to medium term before the company's end markets improve. By comparison, debt/EBITDA was 1.1x as recently as the end of 2013.
EBITDA margins of 7.7% on a latest 12 months (LTM) basis at July 31, 2016 were approximately half of the peak level of 14.3% in 2013 as calculated by Fitch. Margins could begin to improve in fiscal 2017 as Deere implements cost reductions the company estimates could total at least $500 million annually by the end of 2018. Results at Financial Services are being negatively affected by lower residual values on leased equipment and higher provisions for credit losses, but Fitch believes delinquencies are at manageable levels and they remain slightly below the long term average.
FCF at Deere Equipment, including dividends received from financial services, has declined significantly due to weaker operating results but remains positive. Fitch expects FCF after corporate dividends will be approximately $500 million in 2016 (slightly negative excluding dividends from Financial Services) compared to $1.5 billion in 2015.
The impact of lower operating cash flow expected by Fitch is partly offset by a reduction in capital expenditures which were high prior to 2015 when Deere was expanding capacity and developing Tier 4 emissions-compliant engines. Deere Equipment receives dividends from Financial Services that totaled $680 million in 2015. Fitch expects dividends from Financial Services could decline in 2016 based on the downturn in agricultural equipment which is contributing to higher losses on lease residual values and higher provisions for credit losses. The dividends can vary depending on cash requirements at each business.
Fitch expects capital expenditures and dividends will remain relatively stable until conditions improve and Deere is able to rebuild its operating performance. Cash deployment for share repurchases has been much lower in 2016 following several years of high spending that was largely funded by strong FCF. Pension plans are well funded and contributions in 2016 are estimated by Deere at $80 million. As of the Oct. 31, 2015, the net pension obligation totaled $1 billion (92% funded).
Transactions between Deere Equipment and Financial Services include receivables from unconsolidated subsidiaries and affiliates. The majority of these receivables, which totaled, $2.4 billion at July 31, 2016, were due from Financial Services. Deere uses these receivables, as well as capital contributions to, and dividends from, Financial Services to manage leverage at Financial Services and use consolidated cash effectively.
Under Fitch's criteria for rating non-financial corporates, Fitch calculates an appropriate debt/equity ratio of 6x at Financial Services based on solid asset quality, sufficient liquidity and strong funding profile. Actual debt/equity as measured by Fitch, including intangible assets, was 7.7x as of July 31, 2016. As a result, an equity injection of approximately $1.1 billion would be needed to reduce Financial Services leverage to 6x. Fitch assumes Deere could reclassify as equity a portion of intercompany receivables due from Financial Services that totaled $2.4 billion as of July 31, 2016. As a result, it would not be necessary for Deere to issue debt to fund the equity injection.
KEY RATING DRIVERS - JDCC
JDCC's long- and short-term ratings are equalized with Deere's ratings, reflecting Fitch's view of JDCC as a core subsidiary of Deere based on the 100% ownership, shared brand name, importance of JDCC to help Deere achieve its strategic objectives and the Support Agreement between the two entities. The Support Agreement requires Deere to maintain 51% ownership of JDCC, maintain JDCC's net worth at not less than $50 million, and maintain JDCC's fixed-charge coverage at not less than 1.05x on a quarterly basis.
Beyond these support-driven considerations, Fitch also considers JDCC's consistent operating performance, solid asset quality through cycles, sufficient liquidity, and strong funding profile. These factors are counterbalanced by JDCC's elevated leverage relative to stand-alone finance companies, but consistent with captive finance peer averages.
Asset quality metrics were solid, despite an uptick in write-offs during 2016. At July 31, 2016, delinquencies greater than 30 days past due amounted to 1.51% compared to 1.03% one-year prior. Write-offs, net of recoveries were $53.5 million or 0.25% of net finance receivables in the first nine months of fiscal year (FY) 2016 compared to $30.7 million or 0.14% of net finance receivables in the same period in FY 2015. The increase in write-offs was driven by construction and forestry retail notes and revolving credit lines. The allowance for credit losses amounted to $113.3 million, or 0.39% of net finance receivables, as of July 31, 2016. Given strong asset quality performance over the last several years, metrics are expected to normalize in the medium term. Fitch believes JDCC's loss reserves are sufficient to cover potential losses on its receivables.
Operating performance remained consistent, albeit weaker than 2015, amid weaker economic conditions that contributed to increased credit costs and lower origination volumes. JDCC reported revenues through the first nine months of FY 2016 of $1.55 billion, a 7.4% increase from the same period in the prior fiscal year. Pretax income was $398 million, or a 31.5% decrease. This translated to pre-tax ROAA of 1.65%, which is lower than the four-year average of 2.34%. Net income amounted to $258.6 million, or a 31.1% decrease year-over-year. The declines were primarily due to higher losses on lease residual values, less favorable financing spreads and a higher provision for credit losses. Despite year-over-year volatility and weakness, Fitch expects overall operating performance will remain relatively stable and the company will remain profitable in the near- to medium-term.
JDCC's debt-to-tangible equity was 8.17x as of July 31, 2016, up from 7.87x at the end of FY 2015 and 7.82x at FYE 2014. Fitch notes that leverage remains consistent with other captive finance peers but higher than many stand-alone finance companies. Fitch does not anticipate any significant changes in JDCC's overall capital structure. Should funding requirements increase, Fitch believes Deere would inject additional capital into the finance arm, as necessary, to manage JDCC's overall leverage profile.
Fitch believes JDCC's comprehensive funding platform, in combination with the financial strength of its parent, is consistent with other captive finance companies.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Deere Equipment include:
--Deere's revenue declines approximately 10% in 2016;
--The industry downturn in agricultural equipment approaches a cyclical trough in 2017;
--EBITDA margins fall by more than half on an aggregate basis between the industry peak in 2013 and the end of 2016 but begin to recover in 2017;
--FCF declines to approximately $500 million in 2016 including dividends from Financial Services;
--Share repurchases are reduced in 2016 to much lower levels compared to more than $2 billion in each of the past two years.
Fitch's key assumptions within the rating case for JDCC include:
JDCC's long- and short-term ratings are equalized with Deere's ratings, reflecting Fitch's view of JDCC as a core subsidiary of Deere based on the 100% ownership, shared brand name, importance of JDCC to help Deere achieve its strategic objectives and the Support Agreement between the two entities.
RATING SENSITIVITIES
Deere Equipment
Future developments that may, individually or collectively, lead to a negative rating action include:
--Loss of significant market share in the company's agricultural, construction and forestry equipment markets;
--Margins fail to improve materially as Deere implements restructuring and when market demand eventually recovers;
--Deere's precision agriculture and other digital strategies become uncompetitive;
--Cash deployment for share repurchases or acquisitions leads to materially higher leverage;
--Financial Services requires significant support that reduces Deere's liquidity and financial flexibility.
Fitch views a positive rating action as unlikely over the rating horizon due to cyclicality in Deere's agricultural and construction markets and to funding and credit risks at Financial Services.
JDCC
Future developments that may, individually or collectively, lead to a negative rating action include:
--A change in the perceived relationship between Deere and JDCC, for example, if Fitch believed that JDCC was no longer core to Deere's strategic operations and/or adequate financial support was not provided to the captive finance company in a time of need;
--Significant asset quality deterioration;
--Consistent operating losses;
--A material change in balance sheet leverage;
--Deterioration in JDCC's liquidity profile.
Positive rating momentum for JDCC and its subsidiaries would be limited by Fitch's view of Deere's credit profile, as JDCC's ratings and Outlook are linked to that of its parent. Fitch cannot envision a scenario where the captive would be rated higher than its parent.
LIQUIDITY AND DEBT STRUCTURE
Deere Equipment's liquidity at July 31, 2016 included cash of $3.1 billion, excluding $40 million of marketable securities, and availability under two $2.9 billion revolvers shared with JDCC that mature in 2020 and 2021. The agreements require JDCC to maintain minimum fixed charge coverage and maximum debt-to-capital ratios, and Deere Equipment to maintain a maximum debt-to-capital ratio, all of which were in compliance as of July 31, 2016. Deere also has $1.5 billion of other committed and uncommitted facilities. Liquidity was offset by $262 million of short-term debt and long-term debt maturities.
JDCC's liquidity is sufficient given consistent operating cash flow generation, available cash on hand of $1.1 billion as of July 31, 2016 and undrawn capacity under its credit facilities. JDCC relies on the global debt capital markets, various bank funding programs as well as periodic ordinary support from Deere to provide liquidity for its operations. Additionally, 80.9% of JDCC's debt was unsecured, as of July 31, 2016. This is viewed positively by Fitch, as unencumbered assets provide balance sheet flexibility in times of market stress.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
Deere & Company
--Long-Term IDR 'A';
--Senior unsecured bank credit facilities 'A';
--Senior unsecured debt 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
John Deere Capital Corporation
--Long-Term IDR 'A';
--Senior unsecured bank credit facilities 'A';
--Senior unsecured debt 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
John Deere Cash Management S.A.
--Long-Term IDR 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
John Deere Canada ULC
--Long-Term IDR 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
John Deere Financial Inc. (Canada)
--Long-Term IDR 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
John Deere Canada Funding, Inc.
--Long-Term IDR 'A';
--Senior unsecured debt 'A'.
John Deere Bank S.A.
--Long-Term IDR 'A';
--Senior unsecured bank credit facilities 'A';
--Senior unsecured debt 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
John Deere Financial Ltd. (Australia)
--Long-Term IDR 'A;
--Senior unsecured debt 'A';
--Short-Term IDR 'F1';
--Commercial paper 'F1'.
The Rating Outlook is Stable.
Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.
Additional information is available on www.fitchratings.com
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016)
https://www.fitchratings.com/site/re/884128
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014002
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