April 25, 2017 / 3:46 PM / in 3 months

Fitch Assigns Schaeffler AG First-Time 'BBB-' IDR

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(The following statement was released by the rating agency) PARIS, April 25 (Fitch) Fitch Ratings has assigned German automotive and industrial supplier Schaeffler AG first-time Issuer Default and senior secured ratings of 'BBB-'. The Outlook on the Issuer Default Rating (IDR) is Stable. Fitch has also assigned a first-time IDR and a senior secured rating of 'BB+' to Schaeffler's immediate parent and 75.1% owner, IHO Verwaltungs GmbH (IHO-V). The Outlook on the IDR of IHO-V is Stable. The 'BBB-' ratings on Schaeffler incorporate a one-notch uplift from the consolidated rating of the IHO-V group (which includes Schaeffler and the dividend stream from IHO-V's investment in Continental AG, BBB+/Stable). Fitch views the linkage between Schaeffler and IHO-V as weak to moderate under its "Parent and Subsidiary Linkage" criteria, allowing Schaeffler to be rated higher than its parent. The ratings of Schaeffler reflect its solid business profile, exemplified by large size, good customer diversification and strong positions in automotive supply markets, coupled with a moderate financial profile. It has stable cash flows, good financial flexibility and an improving capital structure. The 'BB+' ratings of IHO-V reflect the weaker credit profile of the combined group relative to Schaeffler's standalone credit profile. The ratings of IHO-V include Schaeffler as well as the dividend income from the company's 36% direct holding in Continental. The FFO-adjusted net leverage metric of the combined group is significantly higher than that of Schaeffler, above 3.0x, a level more commensurate with the low-end of the 'BB' rating category. IHO-V's 36% equity stake in Continental (valued at about EUR14.4bn at April 2017) is a significant asset. The value of this minority stake is not explicitly reflected in Fitch's credit metrics, only the dividends received. Fitch would expect a partial stake in this listed company could be sold down fairly swiftly, which could allow IHO-V to repay all its gross debt. The presence of this potential liquidity source supports weaker credit metrics at the IHO-V level. KEY RATING DRIVERS Strong Business Profile: Schaeffler's ratings are underpinned by a business profile that Fitch views as in the 'BBB' category. The company benefits from its large scale, its positioning on high value-added parts, a top-ranking position in quality and reliability-driven market segments, and a solid track record of innovation. Fitch expects the long-standing relationships with large and renowned original equipment manufacturers (OEMs) and its sound end-market diversification to continue. Schaeffler also benefits from its broad industrial footprint, with presence in both developed and emerging markets, matching OEMs' production hubs. Solid Growth Prospects: Fitch expects Schaeffler to outperform the light-vehicle production growth rate over the foreseeable future. The group has demonstrated its capacity to sustainably increase the value of its content per vehicle by enhancing existing products, developing integrated systems and accompanying changes in requirements and standards by bringing innovative solutions into the markets. Strong organic growth is likely in the aftermarkets businesses, where the massive increase in car sales in China will provide growth opportunities. In China, the company is also likely to benefit more from its greater exposure to the fast-growing local OEMs than its peers (34% of local sales compared with typically 15%-20%). Positioned to Benefit from Electrification: The extent and the speed of the transition from hybrid to fully electric vehicles will be critical for Schaeffler because of its focus on mechanical parts for drivetrains. In this context, the group's longstanding relationships with the major OEMs, strong innovation ability and global manufacturing footprint position it favourably to maintain growth in line with the industry. The company already has several customer projects and series contracts for its hybrid modules and e-axles. Sound Operating Profitability: Schaeffler's operating margin of more than 12% over the past five years is well above our expectations for a 'BBB-' rating. In our view, Schaeffler's strong profitability reflects the high added value of its production, a high level of vertical integration and exposure to the more profitable aftermarket businesses. The strong operating margins provide headroom to maintain investment-grade metrics despite the drag on the Automotive division's margins of higher R&D expenditure, a greater share of systems in sales leading to higher purchase content, a risk of growing raw materials prices and slower growth rates in key markets. Mid-Term FCF Pressure: Fitch expects mid-term pressure on free cash flow (FCF) margins, which will be only slightly positive over the next two years. This will result from continuously high investments to support the growth strategy and increasing dividends. Weak expected FCF generation for the current rating is therefore more the result of high investment and increasing dividends, which could be reduced or cut in case of financial stress, rather than a sign of weak underlying profitability. Financial Flexibility Restored: Fitch expects Schaeffler's funds from operations (FFO) net leverage to increase to nearly 2x at end-2018 from lower FFO and pressure on FCF generation, before reducing again to around 1.5x by end-2020 due to improving cash generation as the upswing in the investment cycle ends. This level of leverage will be more commensurate with our expectations for a 'BBB-' rating. Schaeffler has gradually reduced its leverage through a combination of increasing FFO and positive FCF. Fitch also expects IHO-V's net leverage to reduce from around 3.5x in 2017 to around 2.5x by 2020. Parent-Subsidiary Linkage Established: The ratings of Schaeffler are one notch higher than the IDR of IHO-V, due to the higher underlying rating on Schaeffler and the weak to moderate linkage between Schaeffler and IHO-V. Limited documentary constraints on upstreaming of dividends do not ring-fence Schaeffler from additional leverage at IHO-V. Fitch expects dividend payments to remain predictable, and support a modest deleveraging at Schaeffler. DERIVATION SUMMARY Schaeffler's business profile compares adequately with auto suppliers in the 'BBB' rating category. Schaeffler benefits from stronger business diversification than peers, outranked only by Robert Bosch and Continental. Like other large and global suppliers, including Continental and Delphi, it has a broad and diversified exposure to large international OEMs. However, the share of its aftermarket business is smaller than that of tyre manufacturers such as Michelin and Continental. Schaeffler also has stronger operating and cash flow margins than a typical auto supplier that does not benefit from exposure to the tyre businesses. However, Schaeffler's financial structure is typically weaker than 'BBB' rated peers'. Fitch used its "Parent and Subsidiary Linkage" criteria to derive the ratings of Schaeffler. No Country Ceiling or operating environment aspects affect the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - +3.0%-4.0% top line growth over the next four years; - a decline in the gross profit margin in the Automotive division; - an increase in the gross profit margin in the Industrial division; - growing R&D intensity; - working-capital outflows each year; - average capex intensity of 9.0% over 2017-2020; - pay-out ratio of 35%; - no material acquisitions. RATING SENSITIVITIES As the ratings of Schaeffler AG and IHO-V GmbH are linked under Fitch's "Parent and Subsidiary Linkage" criteria, the sensitivities related to each company's ratings are also linked: Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - IHO-V FFO-adjusted net leverage trending towards 2x - Schaeffler's FFO adjusted net leverage at or below 1x - Schaeffler's FCF at or above 2% on a sustainable basis - Weakening of formal linkage ties between Schaeffler and IHO-V Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - IHO-V FFO adjusted net leverage above 3.5x - Schaeffler net leverage above 2.5x - Schaeffler's EBIT margin below 9% on a sustained basis - Schaeffler's FCF margin below 1% on a sustained basis - Strengthening of formal linkage ties between Schaeffler and IHO-V -A reduction in IHO-V's stake in Continental AG without adequate deleveraging LIQUIDITY Heathy Liquidity: Schaeffler's liquidity is supported by EUR0.7 billion of readily available cash at end-2016 according to Fitch's adjustment for minimum operational cash of EUR0.4 billion, representing about 2.5% of revenue. The group had a EUR1.3 billion committed and unused revolving credit line at end-2016, which covers the very limited amount of short-term debt. The maturity profile is not an immediate risk, with no material maturity before 2020. IHO-V's liquidity is also healthy, benefiting from sound interest cover from expected dividends flow and the absence of a material maturity before 2021. Liquidity is further supported by access to a committed and unused EUR0.2 billion revolving credit line at end-2016. FULL LIST OF RATING ACTIONS Schaeffler AG --Issuer Default Rating 'BBB-'; Outlook Stable --Senior Secured 'BBB-'; IHO Verwaltungs GmbH --Issuer Default Rating 'BB+'; Outlook Stable --Senior Secured 'BB+' Contact: Principal Analyst Aurelien Jacqout Associate Director +33 144 299 137 Supervisory Analyst Tom Chruszcz Director +48 22 338 6294 Fitch Polska SA Krolewska 16 00 - 103 Warsaw Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Summary of Financial Statement Adjustments: Operating Leases: Operating lease expenses are capitalised using a multiple of 8x in line with Fitch's criteria; Cash: Reported cash is adjusted by EUR350m to account for seasonal working capital swings and restricted cash. Other: Restructuring costs are treated as operating costs; Legal expenses and gains / losses on asset disposals are treated as non-operating items. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com; Rebecca O'Neill, London, Tel: +44 203 530 1697, Email: rebecca.oneill@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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