CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Trinity Industries Inc. (TRN) at 'BBB-'. In addition, Fitch has affirmed the senior unsecured revolving credit facility at 'BBB-' and TRN's subordinated convertible notes at 'BB+'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings incorporate TRN's low leverage, financial flexibility, and leading industry positions in a majority of the company's business lines. Industry demand in TRN's key railcar market is in a strong part of the cycle and should support results even when demand eventually moderates, although the potential for a sharp industry downturn remains a rating concern. TRN has a substantial railcar leasing business which broadens the company's industry presence and scale and helps to mitigate the impact of cyclicality at the rail and other manufacturing operations. Fitch's assessment of TRN's manufacturing businesses considers Trinity Industries Leasing Company (TILC) on an equity basis.
Rating concerns include cyclicality in most of TRN's manufacturing businesses, potential financial support needed for TILC in a stress scenario, litigation risk, and integration risk related to acquisitions. Fitch expects TRN to adjust cash deployment, including investments in TILC, in order to offset decreased profitability and negative free cash flow (FCF) during cyclical downturns in the manufacturing businesses.
Guardrail litigation represents a significant rating concern following an award against TRN in October 2014 for $525 million of damages under the federal False Claims Act. The total amount could be increased by as much as $184 million of civil penalties to be determined by the U.S. District Court, plus legal fees, interest and other expenses. Timing of the court's final judgment has not been determined and related cases involving other states and class action shareholder lawsuits could lead to additional significant penalties or fines. TRN recently received a subpoena from U.S. Department of Justice for documents related to TRN's guardrail end-terminal products.
TRN's guardrail sales are a relatively small portion of total revenue, so the impact of the litigation on its business is a smaller concern than the amount and timing of any cash payments to resolve the matter. A payment by TRN, including cash collateral for potential bonding requirements during an appeal process, could be material and would reduce the company's liquidity, possibly resulting in a downgrade or negative outlook. However, Fitch considers a more likely scenario to involve a modest bonding requirement or the usage of surety bonds through the appeal process. Fitch assumes a reasonable worst case scenario as approximately $1 billion, but this figure could be higher depending on how the case develops. Following final judgment from the U.S. District Court of Eastern Texas, Fitch expects TRN will appeal the ruling if the outcome is unfavorable to the company. Appeal processes often are lengthy and a final resolution could take as long as several years, allowing TRN to use future FCF to reduce the negative impact of any final legal rulings on liquidity or leverage.
Fitch believes TRN may be able to fund a sizeable penalty of up to $600 million in the near term if liquidity remains strong, TRN's end markets continue to benefit from stable economic conditions, and TRN follows a prudent capital deployment strategy. In the event of a penalty in excess of approximately $600 million, Fitch believes TRN's credit profile could deteriorate below investment grade. However, a lengthy litigation process could provide time for TRN to generate FCF that would improve its ability to handle a large litigation payment.
Fitch estimates manufacturing FCF in 2015 will be near $250 million compared to $153 million in 2014. Fitch expects TRN's operating results will improve due to incremental revenue from Meyer Steel Structures acquired in August 2014 and continued strong railcar sales. FCF excludes cash flow at TILC which Fitch estimates could decline slightly from roughly $100 million in 2014 before considering proceeds from asset sales, primarily railcars. Manufacturing FCF includes the impact of manufacturing and corporate capital expenditures which TRN has budgeted at $250 million - $300 million in 2015.
Fitch expects mid-cycle leverage (gross manufacturing debt/manufacturing EBITDA) to be approximately 1.0 - 1.5x, in line with 1.0x at the end of 2014. Fitch expects credit metrics will remain strong for the rating category which incorporates flexibility to adjust to eventual downturns in TRN's cyclical end markets.
Demand in TRN's railcar market continues to be strong as reflected by a large backlog at the rail group that totaled $6.8 billion as of March 31, 2015. The rail business should also see an increase in retrofit business over the next several years following the recent announcement by the U.S. Department of Transportation (DOT) about enhanced railcar standards under DOT-117. The rule is intended to address concerns about tank car safety for shipments of crude oil and other flammable liquids. In addition, TRN's acquisition of Meyer Steel Structures in August 2014 for nearly $600 million will contribute to growth in TRN's Energy Equipment business.
Fitch anticipates solid near term financial results, including operating margins in the mid-teens, should offset the impact of additional debt incurred at the manufacturing business related to the Meyer acquisition. As a result, Fitch expects TRN will maintain a solid balance sheet to support the leasing business and mitigate normal concerns about cyclicality in the company's manufacturing businesses. The leasing business can be expected to incur costs to modify its tank car fleet related to DOT-117, but the modifications will occur over several years and much of the cost would be expected to be recovered over time from lease customers. Fitch expects any impact on TILC's leverage related to funding the tank car modifications would be modest.
The relationship between TRN and TILC is an important rating consideration. Fitch views TILC as a core part of TRN's railcar business reflecting strong operational and financial linkages between the two companies. In addition, TILC helps offset cyclicality in TRN's manufacturing businesses and increases TRN's presence in the railcar market by providing customers with a single source for purchasing and financing railcars.
TILC's credit strengths include asset quality and financial performance. Fitch considers TILC's asset quality to be strong given the relatively high credit quality of its customer base. Operating performance has benefitted from portfolio growth and strong lease fundamentals. TILC performed well during the previous downturn including low write-offs and the ability to remarket railcars within the fleet.
TILC does not benefit from a formal support agreement from TRN although Fitch believes TRN would support TILC due to TILC's importance to the rail business. An important rating consideration is TRN's ability to maintain a strong balance sheet that mitigates normal risks related to potential disruptions of TILC's usual funding sources or an unexpected decline in the credit quality of TILC's lease portfolio. These risks are also mitigated by substantial unencumbered railcar assets and, to a lesser extent, contingent liquidity under a $1 billion warehouse facility at TILC. TILC bears residual risk on its lease assets, offset by the long economic life of the railcars.
TRN's liquidity at March 31, 2015 included $691 million of consolidated cash and short-term marketable securities, most of which is held at the manufacturing businesses. In addition, $336 million was available under a $425 million revolving credit facility that matures in October 2016. There are no material scheduled long term debt maturities scheduled prior to 2024 at the manufacturing business. Debt used to fund TILC's leasing operations totaled approximately $2.7 billion, including partially owned subsidiaries, and nearly all of the debt is non-recourse.
Fitch's key assumptions within the rating case for Trinity Industries Inc. include:
--Industry railcar demand is strong through 2015 before the cycle matures and demand stabilizes or begins to decline in 2016;
--The near term cash impact of the guardrail litigation is limited to not more than $600 million for any bonding requirements and litigation costs. In the event of a negative outcome from the litigation, Fitch assumes TRN will generate sufficient FCF and limit discretionary spending to fund future litigation-related payments without a material increase in leverage;
--Completion of a $2 billion agreement to sell railcars to Element Financial, of which roughly half had been completed by the end of 2014;
--Implementation of revised tank car safety standards will support TRN's future retrofit revenue; the negative impact on working capital requirements for TILC's fleet will be spread out and will not have a significant effect on TRN's overall cash flow;
--An increase in manufacturing capital spending supports manufacturing sales growth;
--Acquisitions are limited in the near term while TRN integrates Meyer Steel Structures.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Inability to maintain mid-cycle manufacturing leverage between 1.0x - 1.5x, and maintain manufacturing leverage below 3.0x through a downturn;
--A negative outcome related to litigation surrounding TRN's guardrail products or other legal disputes leads to large payments of $600 million or more. A lengthy litigation process could provide time to generate FCF that would reduce concerns about liquidity and leverage;
--EBITDA margins decline and remain below 10%;
--Large debt funded acquisitions and share repurchases;
--Substantial support required for TILC.
An upgrade is unlikely in the near term based upon the cyclicality of TRN's manufacturing business and normal funding and credit risk at TILC. However, long term developments that could lead to a positive rating action include:
--Lower sensitivity to, or diversification away from, TRN's cyclical end markets;
--Less reliance on TILC that would reduce potential support needed in a stress scenario;
--FFO adjusted leverage near 1.5x or below compared to 2.1x at Dec. 31, 2014;
--FCF/total adjusted debt consistently above 20%.
Fitch affirms TRN's ratings as follows:
Trinity Industries Inc.
--IDR at 'BBB-';
--Senior unsecured revolving credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'
--Subordinated convertible notes at 'BB+'
The Rating Outlook is Stable.
The ratings affect approximately $850 million of manufacturing debt outstanding at March 31, 2015.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Parent and Subsidiary Rating Linkage' (May 28, 2014);
--'Global Non-Bank Financial Institutions Rating Criteria' (March 20, 2015);
--'Treatment and Notching of Hybrids in Corporates and REIT Credit Analysis' (Nov. 25, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Global Non-Bank Financial Institutions Rating Criteria
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis