Fitch Affirms Allison Transmission's IDR at 'BB-'; Rating Outlook Revised to Positive

CHICAGO--()--Fitch Ratings has affirmed the Issuer Default Ratings for Allison Transmission Holdings, Inc. (ALSN) and its subsidiary Allison Transmission, Inc. (ATI) at 'BB-'. In addition, Fitch has affirmed the 'BB' ratings on ATI's secured term loans and secured revolving credit facility, and the 'B+' rating on ATI's senior unsecured notes. A full list of the rating actions is included at the end of this release. Fitch's ratings apply to $2.2 billion in secured term loans, a $465 million secured revolving credit facility and $471 million in senior unsecured notes. The Rating Outlooks for ALSN and ATI have been revised to Positive from Stable.

KEY RATING DRIVERS

The ratings for ALSN and ATI are supported by the company's strong competitive position in the global market for fully automatic transmissions for commercial, industrial and military vehicles and equipment. ALSN has a very strong market position in North America, with nearly all school buses and the majority of Type A motorhomes and medium-duty commercial trucks manufactured with the company's transmissions in 2013. In addition, over half of the Class 8 straight trucks sold in North America in 2013 were manufactured with the company's transmissions, and unlike most Tier 1 suppliers, ALSN's brand name commands a price premium from end users. However, ALSN's market position outside North America is significantly smaller, as commercial vehicles in most global markets continue to be produced with manual transmissions. Nonetheless, global acceptance of fully automatic transmissions is growing, particularly for certain vocations, such as buses and emergency vehicles. This has been particularly true in emerging markets such as China and India, where ALSN is well-positioned for future growth opportunities.

The revision of the Outlook to Positive from Stable reflects Fitch's expectation that ALSN's credit profile will continue to strengthen over the intermediate term. Fitch expects leverage to trend down as the company focuses on its targeted net leverage range, and Fitch expects the global diversification of the company's revenue stream to rise as its penetration into emerging markets increases. ALSN's premium pricing and relatively low manufacturing costs have led to consistently strong profitability and free cash flow (FCF) generation, which will continue to provide the company with significant financial flexibility going forward and a meaningful liquidity cushion in the event of an unexpected downturn.

Although ALSN's leverage remains high for the rating category, the company has applied a portion of its strong FCF over the past several years to debt reduction, including a $140 million decline in the last 12 months (LTM) ended June 30, 2014, and leverage is expected to trend down further over the intermediate term as the company focuses on its net leverage target range (net debt/adjusted EBITDA, as calculated by the company) of 3x-3.5x. Modest pension obligations, a strong liquidity position and manageable near-term debt service requirements are other credit positives. Fitch also notes that ALSN's ownership structure has become less concentrated over the past year as The Carlyle Group (Carlyle) and Onex Corporation (Onex) have reduced their combined ownership stake in the company to only 3%, down from 81% at June 30, 2013, through a series of secondary stock offerings.

Fitch's concerns include the heavy cyclicality of the global commercial vehicle and industrial markets, volatile raw material costs, relatively little global diversification of ALSN's current business, moderately high leverage and a concentrated maturity schedule. However, on the last point, Fitch notes that credit facility amendments over the past two years have shifted all of ALSN's term loan obligations to 2017 and 2019, removing the company's near-term refinancing risk. The company's strong profitability and FCF generation place it in relatively good position to manage the cyclical volatility noted above, and it is also notable that ALSN's transmissions are primarily used in the vocational truck market, which tends to be less cyclical than the Class 8 linehaul market, which remains dominated by manual transmissions. Nevertheless, a broad-based global downturn in commercial vehicle and industrial production could pressure ASLN's profitability and FCF.

ALSN's credit profile is characterized by strong margins and FCF generation but relatively high leverage. Fitch-calculated leverage (debt/Fitch-calculated EBITDA) at June 30, 2014, was 4x, with $2.7 billion in debt and LTM Fitch-calculated EBITDA of $667 million. The Fitch-calculated EBITDA margin, at 33.6%, remained very strong for a capital goods manufacturer and was up from 30.2% in the LTM ended June 30, 2012. Fitch expects leverage to trend down over the remainder of 2014 through a combination of EBITDA growth and debt reduction. With strong FCF generation and most of its debt in the form of term loans, ALSN has the financial flexibility to reduce leverage further in the intermediate term if it chooses to do so, although it is likely to be near the high end of its net leverage target range by year-end 2014. The company's liquidity position at June 30, 2014 was more than sufficient to meet its near-term cash obligations and included $127 million in cash and cash equivalents, augmented by $453 million in availability on its $465 million secured revolving credit facility (after accounting for $12 million in letters of credit).

Over the past year, Carlyle and Onex significantly reduced their collective stake in ALSN through four secondary stock offerings, one in the third quarter of 2013 (3Q'13) and three in the 1H'14. As a result of these sales, Carlyle and Onex reduced their combined stake in ALSN to 3% as of June 30, 2014, down from 81% at June 30, 2013. Although Fitch did not previously view the concentrated ownership structure as a significant credit risk, it is nonetheless a mild credit positive that the company's ownership base has become more diversified. However, Fitch expects the company will begin to focus more heavily on returning cash to shareholders through dividends and share repurchases now that its shareholder composition is less concentrated.

ALSN has been focused on reducing debt over the past several years, with debt (including short-term debt) declining from $4 billion at year-end 2008 to $2.7 billion at June 30, 2014. The figure at June 30, 2014 was down $140 million from the level at June 30, 2013, as the company prepaid a portion of its term loans in the latter half of 2013. ALSN has flexibility to further reduce its debt through optional prepayments on its secured term loans. ATI's 7.125% senior unsecured notes also have a soft call provision that allows for early redemption of all or a portion of the notes beginning in May 2015. Fitch expects that the company may look for opportunities to further prepay a portion of its debt over the intermediate term as it continues to work toward its 3x-3.5x net leverage target.

Fitch expects FCF to remain solid over the intermediate term and FCF margins to remain strong by industry standards. LTM FCF was $353 million at June 30, 2014, leading to a strong 17.8% FCF margin. Funds flow from operations (FFO) was $528 million in the LTM period, with working capital using a modest $17 million in cash. LTM capital spending was $71 million, equal to only 3.6% of revenue. The company has guided to full-year 2014 capital spending in the range $60 million to $70 million, and with no significant plant construction activity expected over the intermediate term, capital spending needs are likely to remain relatively low over the next several years. ALSN instituted a common dividend in 2012 and spent $87 million on dividends in the LTM period ended June 30, 2014, which is included in Fitch's FCF calculation. Now that the company's sponsors have sold most of their stake in the company, Fitch expects ALSN to target more cash toward share repurchases as well. In the LTM period ended June 30, 2014, ALSN spent $349 million on share repurchases, all of which were conducted in conjunction with the secondary offerings of the sponsors' stakes.

ALSN's secured revolving credit facility agreement includes a financial covenant that requires the company to maintain a senior secured leverage ratio below 5.5x. However, with the most recent amendment to the facility, the revolver participants have permanently waived the covenant as long as no borrowings are outstanding at any quarter-end. Despite the waiver, ALSN's actual senior secured leverage ratio, which is calculated net of cash, was well below the limit, at 3.11x as of June 30, 2014. According to the facility's terms, a senior secured leverage ratio at or below 3.5x suspends certain provisions requiring excess cash flow (as defined in the agreement) to be applied to term loan reduction. Even without the waiver, Fitch would not expect the senior secured leverage ratio covenant to constrain the company or lead to any credit risk over the intermediate term.

ALSN's pension obligations are modest, with an overfunded status of $2.7 million as of year-end 2013. The company's U.S. hourly pension plan was closed to new entrants in 2008, and benefits for U.S. hourly employees who retired prior to Oct. 2, 2011 are covered under General Motors Company's (GM) hourly plan. Fitch does not view ALSN's pension obligations as a meaningful credit risk.

The secured revolver and term loans that comprise ATI's credit facility are rated 'BB', one notch above ATI's IDR, due to their collateral coverage, which includes virtually all of ATI's assets. Fitch notes that property, plant, and equipment and intangible assets (including intellectual property) comprised $2.1 billion of the $4.8 billion in assets on ALSN's consolidated balance sheet at June 30, 2014. With the secured credit facility accounting for nearly 83% of the debt in ALSN's consolidated capital structure (assuming a fully-drawn revolver), ATI's senior unsecured notes are rated one notch below ATI's IDR at 'B+'.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

-- A decline in Fitch-calculated EBITDA leverage to below 3.5x;

-- An increase in the global diversification of its revenue base;

-- Maintaining EBITDA and FCF margins near current levels;

-- Continued positive FCF generation in a weakened demand environment.

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

-- A sharp decline in commercial vehicle production, especially in North America that leads to significantly lower margins and FCF;

-- An increase in leverage to above 4.5x for a prolonged period;

-- A merger or acquisition that results in higher leverage or lower margins over an extended period;

-- A competitive entry into the market that results in a significant market share loss.

Fitch has affirmed the following ratings and revised the Rating Outlooks to Positive from Stable:

Allison Transmission Holdings, Inc.

--IDR at 'BB-'.

Allison Transmission, Inc.

--IDR at 'BB-';

--Senior secured revolving credit facility at 'BB';

--Senior secured term loan B-2 at 'BB';

--Senior secured term loan B-3 at 'BB';

--Senior unsecured notes at 'B+'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

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

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=847775

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
Eric C. Ause
Senior Director
+1-312-606-2302
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@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
Eric C. Ause
Senior Director
+1-312-606-2302
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com