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Fitch Revises STMicroelectronic's Outlook to Positive; Affirms at 'BBB-'
March 1, 2017 / 5:40 PM / 7 months ago

Fitch Revises STMicroelectronic's Outlook to Positive; Affirms at 'BBB-'

(The following statement was released by the rating agency) LONDON, March 01 (Fitch) Fitch Ratings has revised the Outlook on STMicroelectronics N.V.'s (ST) Long-Term Issuer Default Rating (IDR) to Positive from Stable. Fitch has affirmed STM's IDR and senior unsecured rating at 'BBB-'. ST's rating is supported by the company's strong position within a number of key growth segments in the semiconductor market. The maintenance of a conservative financial policy has offset weaker cash-flow generation compared to industry peers. The restructuring and exit of unprofitable business lines over the past five years is nearing completion, leaving a more focused business that is better positioned to fund R&D, manage cyclical downturns and compete within its areas of focus. The revision of the Outlook to Positive reflects a potential turning point in the company's credit profile on a 12 to 24 month view, driven by higher operating margins and sustained improvements in free cash flow (FCF). These will help build financial flexibility, strengthen ST's existing net cash position, and in conjunction with sustainable improvements in product innovation and design, support a rating at the 'BBB' level. KEY RATING DRIVERS Business Focus on Growth Segments: STMicroelectronics' product portfolio focuses on the automotive and internet of things (IoT) segments of the semiconductor market. These cover around 50% of a USD330bn global semiconductor market. Fitch expects both segments to grow faster than the overall semiconductor sector on average and support the company's revenue prospects over the next two to three years. IoT is a broad and fragmented segment that is rapidly evolving. ST has an early positioning within the segment and a number of attributes that are likely to help it succeed. These include broad product and application skills and an indirect distribution capability. In automotive, growth is being driven by an increase in the proportion of silicon content in cars as a result of electrification, infotainment, autonomous driving and safety applications. The company's investments in silicon carbide technology which increases the efficiency of power applications are coming to fruition and likely to drive an increase in revenue from 2H17. Automotive Segment Credit Supportive: ST is one of the top-four global suppliers of semi-conductors to the automotive industry. Strong end-customer relationships in the segment improve R&D returns, product design and help retain its market position. The company's Automotive and Discrete division accounts for 40% (2016) of total group sales and over 50% of total operating profit. The segment has long product life cycles that enhance revenue visibility while providing good product diversification to ST's consumer applications in IoT that in our opinion reduce operating volatility and thus supportive of its credit profile. Credit Profile Potentially Turning: ST's exit of its last major unprofitable business unit will largely be complete in 2017 following the restructuring of its set-top box business. This will leave a more focused business that is better structured and positioned to compete on a sustainable basis. A combination of revenue growth, improved product mix, cost control, efficiency measures and greater fab utilisation will support profit margin expansion as the impact of less profitable parts of the business come out of the mix. These effects are partially visible in 4Q16 financial performance. Fitch expects that operating profit (excluding impairment and restructuring charges) will grow to around 10% in 2017 from 4% in 2016. Underlying Cash-Flow Growth: ST is likely to be able to convert operating margin growth into FCF growth from 2018. In the short term, increases in capex will prevent this from occurring. ST will raise capex to USD1.0 - USD1.1bn in 2017 from USD607m in 2016. The increase is on the back of design wins that have led to an upgrade of manufacturing capabilities. We expect capex to fall to around USD800m, or 10% of sales by 2018 on a sustainable basis. Assuming there is no change to ST's dividend policy or no significant cyclical event, this is likely to lead to an expansion in FCF margin to around 5% in 2018 from 2% in 2016 (including restructuring charges). Improving Financial Flexibility: ST has a conservative financial policy and maintains a net cash position that has supported its rating through historical restructuring and cyclical downturns. Growth in EBITDA is likely to see leverage (total debt to EBITDA) decrease to around 1.1x by end-2017 from 1.5x end-2016. The potential conversion of USD600m of bonds to equity in 2019 is likely to see this fall further to 0.5x. In addition, cash-flow growth is also likely to provide scope to strengthen the company's cash reserves. Dimensioning for Cyclical Downturns: ST's segment-focused approach and improvements in operating margins will improve the company's ability to manage cyclical downturns. Fitch's stress-case scenario of a 'Medium' level downturn that leads to a 6% yoy drop in revenues in 2018 indicates a 50% decline in adjusted EBIT margin to 4.5% and a decline in FCF margin to 1%-2%. This assumes R&D expenditure is maintained and dividends are not cut. The ability to reduce capex, constrain selling, general and administrative costs, and release working capital helps limit the impact on FCF. Industry Shift and Consolidation Support: Recent sector consolidation has been driven by slowing revenue growth, demand for integrated solutions and increasing features on single chip sets. ST's focus on growth segments and broad product capabilities has removed the need to react quickly. The company from this point of view, is well positioned. However, the growing scale of rivals will require a deepening of partnerships, increasing business focus and greater customer understanding to ensure productive R&D, innovation and a sustainable competitive position. In the medium term, consolidation may reduce the frequency and depth of overcapacity driven cyclicality in the sector. DERIVATION SUMMARY ST's rating is driven by its strong position in the automotive sector, exposure to growth segments of the semiconductor market, broad product skills and the maintenance of a conservative financial policy. Operating margins and FCF generation, although improving strongly are still lower than the industry average. These are restraining factors which lead to a more cautious approach to the rating relative to peers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for ST include: - revenue growth of 10.5% in 2017 declining to 2% by 2019 and no cyclical downturns; - gross margin increasing to 37.8% in 2017 from 35.2% in 2016; - stable SG&A and R&D of USD2.25bn per annum; - adjusted EBIT margins expanding from 4.4% in 2016 to 10% in 2017; - capex increasing to USD1.1bn in 2017 and remaining at around 10% of sales thereafter; - stable dividend payments of USD219m per year; - convertible bonds are not exchanged for equity and paid back in cash in line with Fitch's approach to bonds that have no mandatory obligation to convert into equity. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Through the cycle consolidated operating margins trending consistently in the mid to high-single digit range - At least mid-single digit free cash flow margin (post-dividend cash flow to sales) with some resilience in a downturn. - The maintenance of a conservative financial policy including a net cash position - Stable operating environment and improving competitive market position. Future Developments That May, Individually or Collectively, Lead to a Downgrade - Failure to generate anything more than zero to low-single digit operating margins on a consolidated basis - Failure to maintain a sustainable net cash position, in the event that FCF visibility and or margins do not improve - Weakening in competitive position or increase in competition that would impair the company's ability to generate positive free cash flow. LIQUIDITY Healthy Liquidity: As of 2016, ST had a strong liquidity profile, with unrestricted cash of USD1,964m that is sufficient to cover the repayment of all debt instruments. Contact: Principal Analyst Joe Howes Analyst +44 20 3530 1382 Supervisory Analyst Tajesh Tailor Director +44 20 3530 1726 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@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 analyst. 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