CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Snap-on Inc., including the company's Issuer Default Rating (IDR) at 'A-'. The Rating Outlook has been revised to Positive from Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings reflect the company's strong operating performance, high level of brand loyalty among its customers, conservative financial policies, consistent free cash flow generation and solid liquidity position. These factors are balanced against the company's sensitivity to business cycles and Snap-on's dependence on the auto repair market. The Positive Outlook reflects the improvement in Snap-on's operating and credit metrics over the past four years and Fitch's expectation that these trends will continue.
Improving Operating Results
Sales at Snap-on's manufacturing operations grew 4.1% in the first half of 2015, on top of 7.2% growth in 2014. On an organic basis (excluding the effect of acquisitions and foreign currency translation), sales grew a healthy 9.1% in the first half compared with 6.9% in 2014. Strong top-line growth has been driven by solid growth at each of Snap-on's three manufacturing segments: Commercial and Industrial (28% of latest 12 months manufacturing sales), Snap-on Tools (46%) and Repair Systems and Information (26%), and at the financial services segment. Fitch expects Snap-on will maintain a mid-single digit top line growth rate over the medium term.
EBITDA margins before financial services improved to 20.6% in the 12 months ended July 4, 2015, from 19.9% in 2014 and 18.8% in 2013. This improvement reflects the effect of sales volume leverage and savings from rapid continuous improvement initiatives. Fitch believes there is additional upside to the manufacturing operating margin in the near term due to continued healthy volume growth and ongoing cost savings efforts.
Conservative Financial Strategy
Snap-on employs a conservative financial strategy. Snap-on borrows all public debt at the parent level, which funds its financial services operations directly. The company allocates debt internally between its manufacturing and financial services segments, and, with the growth of its finance operations, substantially all of the company's debt is now fully allocated to the financial services segment.
Snap-on internally manages leverage at the financial services level at a debt to equity ratio of 5x, though it is currently below this level, at around 4x. This leverage target is somewhat conservative compared with other captive finance subsidiaries rated by Fitch but is appropriate based on the quality of receivables financed. Fitch expects the company will maintain financial services leverage at current levels over the near to intermediate term as receivables growth will likely be funded with operating cash flow and debt levels will be flat.
Leverage at the manufacturing level as measured by debt to EBITDA was 0.1x for the LTM period ending July 4, 2015, in-line with year-end 2014. Fitch expects manufacturing leverage will remain at low levels as its capital requirements are being funded with internally generated cash flow. On a consolidated basis, including the finance operations, leverage improved to 1.1x for the LTM period ending July 4, 2015 compared with 1.2x at year-end 2014, 1.4x at year-end 2013 and 1.6x at year-end 2012. Fitch expects consolidated leverage will remain in the low-1x range over the next 12-24 months.
The company generates robust FCF, totaling $220 million during the 12-months ended July 4, 2015 compared with $210 million during 2014 and $230 million during 2013. Fitch expects Snap-on will generate FCF of $200 to $250 million annually (6-7% of revenues) over the next two years.
The company remains disciplined in the uses of its cash and cash flow and Fitch expects this to continue. Fitch expects FCF will be used to fund acquisitions, fund pension liabilities and pay dividends. Fitch also expects management will continue to make moderate share repurchases, primarily to offset dilution from stock awards.
Focus on Auto Repair Market
The primary risk facing Snap-on is the company's dependence on the auto repair market, which accounts for around 70% of sales and which is moderately cyclical as car owners will tend to delay repairs and maintenance during an economic downturn. Sales dropped in 2008-2009, especially for big ticket diagnostic and undercar equipment, but have since grown at a healthy rate (annual growth rates of 7-11% over the past four years) with additional growth upside as vehicles continue to age and become more technically complex.
Snap-on has diversified its operations by extending its presence into critical industries outside the automotive repair segment, including the aerospace, military, oil and gas, natural resources and power generation industries. Fitch expects Snap-on will continue to look for acquisition opportunities, particularly bolt-on acquisitions that would allow the company to expand into emerging markets, critical industries and enhance its capabilities in serving vehicle repair facilities.
Financial Services Segment
Snap-on provides customer financing through its financial services businesses, providing strategic advantages to Snap-on in terms of attracting and retaining customers by structuring flexible payment terms. The company employs consistent underwriting standards and prudent risk management. Asset quality metrics are considered strong given the portfolio's sub-prime orientation, supported by weekly, in-person collections by the franchisees.
The company's on-balance sheet receivables portfolio has grown to approximately $1.4 billion as of July 4, 2015. Snap-on's decision to restrict the financial services segment's activity to captive finance mitigates some risks associated with managing a finance subsidiary. The business continues to exhibit higher profitability than its captive finance peers given the relatively subprime nature of its portfolio.
Fitch's key assumptions within its rating case for the issuer include:
--Revenues grow at 4% in 2015 and 5% annually thereafter;
--EBITDA margins expand by 40bps in 2015 and are flat thereafter;
--FCF ranges from $200-$250 million annually, in line with recent experience;
--Consolidated Debt/EBITDA is steady at 1.0-1.1x.
Factors that could lead to a positive rating action include continued healthy top-line growth at or above market growth rates, further improvement in consolidated EBITDA margins above 20%, FCF margins of 6-7%, steady asset quality metrics and financial leverage in the financial services business, and maintenance of debt/EBITDA at the manufacturing operations of less than 1x, even in the event of a larger acquisition.
Factors that could lead to a negative rating action include deterioration in market fundamentals resulting in a sustained reduction in sales and cash flow or a large acquisition leading to an increase in leverage at the manufacturing operations to above 1.5x for an extended period. A negative rating action would also be considered if the financial services operation experiences a substantial deterioration in asset quality and higher leverage levels that require meaningful support from the manufacturing operations.
Snap-on maintains solid liquidity including an undrawn $700 million revolver that backs commercial paper borrowings. Nearly all of the company's $124.6 million total reported cash as of July 4, 2015 is held at the manufacturing segment with a small amount held at the financial services segment. $104.0 million of reported cash is currently held overseas with no near-term expectation of repatriation, leaving $20.6 million as readily-available. The company's next debt maturity is in January 2017, when $150 million of senior notes are due.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings for Snap-on with a Positive Outlook:
--IDR at 'A-';
--Senior unsecured debt at 'A-';
--Unsecured revolving credit facility at 'A-';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Date of Relevant Rating Committee: Sept. 25, 2015
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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