Fitch Affirms BorgWarner's IDR at 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed BorgWarner Inc.'s (BWA) Long-Term Issuer Default Rating (IDR) at 'BBB+' and Short-Term IDR at 'F2'. Fitch has also affirmed BWA's unsecured credit facility and senior unsecured notes ratings at 'BBB+' and Commercial Paper (CP) Program Rating at 'F2'. A complete list of ratings follows at the end of this release. Fitch's ratings apply to a $1 billion unsecured revolving credit facility, $2.2 billion in senior unsecured notes and a $1 billion CP program. The Rating Outlook for BWA is Stable.

KEY RATING DRIVERS

BWA's ratings are supported by the company's strong competitive position as a key global supplier of automotive engine and drivetrain components, its significant free cash flow (FCF) generation potential and solid liquidity position. The company's efficient capacity utilization and relatively low cost structure continue to drive margins that are among the highest in the U.S. auto supply industry, contributing to its consistently positive annual FCF and providing it with significant financial flexibility. BWA weathered the last recession relatively well, and with a product portfolio largely focused on technologies that enhance fuel efficiency, such as turbochargers and dual-clutch transmission components, Fitch expects its sales to outpace global light vehicle production growth over the intermediate term. Further supporting the ratings, BWA's late-2015 acquisition of Remy International, Inc. (REMY) has significantly enhanced its capabilities in technologies for electric and hybrid vehicles. The acquisition has also provided it with the opportunity to combine its existing products with REMY's technology to further broaden its component offerings.

Fitch's concerns include BWA's ongoing interest in acquisitions, which could result in increased leverage over the longer term and its heightened focus on shareholder-friendly activities. Fitch does not expect the company to make another acquisition as large as the REMY acquisition in the near term; however, BWA would likely not hesitate to make smaller acquisitions, potentially debt-funded, given the right opportunities. In terms of shareholder-friendly activities, in 2015, BWA launched a $1 billion three-year share repurchase program. It spent $350 million on share repurchases in 2015, and plans to spend between $200 million and $300 million on repurchases in 2016. This was in addition to common stock dividends, which totaled $117 million in 2015 and $56 million in the first half of 2016. Fitch's concerns regarding acquisitions and shareholder-friendly activities are mitigated somewhat by the company's consistently positive FCF generation, which Fitch expects to grow over the intermediate term.

The large proportion of BWA's consolidated cash located outside the U.S is an additional rating concern. At June 30, 2016, only $9.9 million of the company's consolidated $495 million cash balance was located in the U.S. Although the company needs to maintain significant cash balances outside the U.S. to fund its sizeable non-U.S. operations (75% of its revenue in 2015 was generated outside the U.S.), leverage could rise if the company chooses to fund dividends, share repurchases or any U.S. acquisitions with long-term debt instead of repatriated cash. Fitch could consider a negative rating action if the company were to increase leverage to fund its U.S. cash needs over the intermediate term.

The Stable Rating Outlook is predicated on Fitch's expectation that BWA's leverage will decline to a level consistent with its 'BBB+' IDR over the next 24 months as the company de-levers following the REMY acquisition. By the end of 2016, Fitch expects EBITDA leverage to decline to the mid-1x range and FFO adjusted leverage to decline to the low-2x range, and expects both to decline further in 2017. BWA's leverage is currently elevated, as the company partially funded the acquisition with the proceeds from a EUR500 million notes issuance in November 2015. The company designated the Euro-denominated notes as a hedge against its substantial Euro-denominated cash flows.

Absent any debt-funded acquisitions, Fitch expects BWA's leverage to decline once a full 12 months of REMY EBITDA is included in the company's figures and as it works to get leverage back down to its net debt to net capital target range of 15% to 30%. As of June 30, 2016, BWA's actual net debt to net capital ratio (based on its own calculation) was 36.3%, largely as a result of incremental debt incurred in conjunction with the REMY acquisition. At the same time, BWA's EBITDA leverage, based on Fitch's calculation (debt/Fitch-calculated EBITDA), was 1.8x and FFO adjusted leverage was 2.7x. Both of these figures include an assumption of off-balance sheet factoring, which was incurred with the REMY acquisition.

Near-term debt maturities are manageable. Fitch expects that CP borrowings are likely to rise and fall somewhat with the company's cash needs, while other short-term borrowings are likely to be largely rolled over. Over the longer term, BWA's leverage could rise at times when the company makes acquisitions. However, Fitch generally expects BWA's relatively strong operating cash flow will provide it with sufficient flexibility to fund capital spending, dividends, share repurchases and smaller acquisitions without the need for significant incremental long-term borrowing.

In addition to $270 million in commercial paper borrowings at June 30, 2016, BWA had $81 million in other short-term debt and $164 million in current maturities of long-term debt coming due in the next 12 months. BWA has the opportunity to reduce leverage in the intermediate term by repaying its upcoming $150 million senior unsecured note maturity in November 2016 with cash and/or temporary CP borrowings. Following the November maturity, BWA has no further material maturities until 2019, when its revolver and $134 million in senior unsecured notes come due.

Fitch expects BWA to produce relatively strong FCF over the intermediate term, with post-dividend FCF margins generally running in the mid-single digit range, which is strong for an auto supplier. FCF was pressured somewhat over the past two years due to elevated capital spending tied to some specific projects, but it will likely trend back to more normalized levels over the course of 2016 and into 2017. Capital intensity (capital spending/revenue) averaged 7% in 2014 and 2015, but Fitch expects it to equate to about 5.5% in 2016 and decline to around 5% in 2017 and beyond. Fitch expects the effect of share repurchases to largely offset the effect of any increase in the dividend rate on overall dividend spending, which will further support increased FCF over the intermediate term. FCF after dividends in the last-12-months (LTM) ended June 30, 2016 was $241 million, equal to a 2.8% FCF margin. However, for the full year 2016, Fitch expects FCF to grow as the company benefits from higher business levels, additional FCF from the REMY acquisition, and the lower level of capital spending. This could lead to a FCF margin of close to 4% in 2016 and 5% or higher in later years.

Fitch expects BWA's liquidity to remain adequate over the intermediate term. At June 30, 2016, BWA had $495 million in consolidated cash and cash equivalents, but as noted earlier, only 2% of this was located in the U.S. However, Fitch expects the company will repatriate cash from outside the U.S. at a level sufficient to cover most of its domestic cash needs not covered by cash generated in the U.S. In addition to its cash, BWA had $730 million in availability on its $1 billion unsecured revolver, after accounting for the $270 million in CP backed by the facility. Relatively strong FCF will help to bolster BWA's liquidity in later years.

BWA's pension plans remain relatively well funded. BWA's legacy U.S. plans have been closed to new entrants since 1999, while the REMY plans remain open. At year-end 2015, the company's U.S. plans were 78% funded, with an underfunded status of only $65 million. The company also sponsors defined benefit plans in certain countries outside the U.S., some of which are generally unfunded. BWA did not make any contributions to its U.S. plans in 2015, but it contributed $19 million to its non-U.S. plans during the year. In aggregate, the company's non-U.S. plans were also 78% funded at year-end 2015, with an underfunded position of $113 million. The company expects to contribute between $15 million and $25 million to its global plans in 2016, including $8.5 million of contractually-required contributions. The remainder of the planned contributions will be voluntary. Given the relatively low underfunded level of BWA's pension plans, particularly its U.S. plan, Fitch does not currently view BWA's pension plans as a meaningful credit risk.

KEY ASSUMPTIONS

--Low-single-digit global auto production growth over the intermediate term;

--An increase in new business wins and increased penetration rates result in organic revenue growth in excess of global vehicle production growth;

--Capital spending runs at about 5% of revenue over the intermediate term;

--The common stock dividend rate rises over time, but total cash spent on dividends is about flat on a reduced share count;

--The company makes modest to moderately sized acquisitions from time to time.

--The company repays its November 2016 debt maturity with cash on hand;

--The company generally maintains about $450 million to $550 million in cash on its balance sheet, with excess cash used for acquisitions or share repurchases.

RATING SENSITIVITIES

Positive: Given the inherent cyclicality and potential financial pressures of the auto supply industry, an upgrade of BWA's ratings is unlikely in the intermediate term.

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

--An unexpected sharp drop in global auto production;

--Not de-levering back to below 1.5x over the intermediate term;

--A decline in the company's EBITDA margin to below 12%;

--A significant increase U.S. long-term debt to support shareholder-friendly actions, particularly if accompanied by a decline in the repatriation of non-U.S. cash.

Fitch has affirmed the following ratings:

--Long-Term IDR 'BBB+';

--Short-Term IDR 'F2';

--Unsecured revolving credit facility 'BBB+';

--Senior unsecured notes 'BBB+';

--Commercial Paper Program Rating 'F2'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Fitch has adjusted BWA's debt to include an estimate of off-balance sheet factored receivables.

Additional information is available at '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/site/re/869362

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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
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Committee Chairperson
Robert Hornick
Senior Director
+1-212-908-0523
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@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
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Committee Chairperson
Robert Hornick
Senior Director
+1-212-908-0523
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com