August 21, 2012 / 6:27 PM / 5 years ago

TEXT-S&P revises UCI Holdings outlook to negative

Overview
     -- U.S.-based vehicle replacement parts manufacturer UCI Holdings Ltd. 
(UCI) has experienced general softness in the aftermarket through the second 
quarter of 2012 despite a slight increase in miles driven and lower gas prices.
     -- We are revising our rating outlook to negative from stable and 
affirming all of our ratings on UCI, including our 'B' corporate credit rating.
     -- The negative outlook reflects our view that over the next year there 
is a one-in-three chance the company's leverage will remain higher than our 
assumption for the current rating (including adjusted debt to EBITDA of just 
above 5x). 

Rating Action
On Aug. 21, 2012, Standard & Poor's Ratings Services revised its outlook on 
UCI Holdings Ltd. to negative from stable and affirmed its 'B' corporate 
credit rating on the company.

We also affirmed our 'B+' issue rating on UCI's senior secured credit 
facility. The credit facility has a '2' recovery rating, indicating our 
expectation for substantial (70%-90%) recovery in the event of payment 
default. We affirmed our 'CCC+' issue-level ratings and '6' recovery ratings 
on the company's $400 million unsecured notes due 2019. The '6' recovery 
rating indicates our expectation for negligible (0-10%) recovery.

Rationale
The rating on UCI reflects Standard & Poor's view of the automotive 
aftermarket company's business risk profile as "fair" and its financial risk 
profile as "highly leveraged." UCI is the parent company and guarantor of 
financings of UCI International Inc. The privately held company is
owned by an affiliate of New Zealand private investor Graeme Hart's Rank Group
Ltd. An affiliate of Rank Group also owns aftermarket parts company Autoparts
Holdings Ltd. (B/Stable/--). UCI and Autoparts have a common senior management
team. 

UCI and Autoparts also have significant operational consolidation, and we 
believe the two companies may eventually be legally consolidated given that 
they each have filtration businesses and have the same ultimate owner, 
although existing financial agreements prevent full consolidation for now. If 
Autoparts and UCI remain separate legal entities, we believe it could impair 
their stand-alone viability.

Given their business commonality, the two companies have represented they 
negotiate sourcing agreements on an arm's length basis to document the terms 
of sale of product between the two companies. (Arm's length is a business term 
for an agreement between two independent, unrelated parties who are looking 
out for their own interests.) As part of increasing operational integration, 
Autoparts is closing two manufacturing locations for its FRAM Group filters. 
Other FRAM and UCI manufacturing locations will make up the lost production, 
and UCI will purchase certain equipment from Autoparts. Also, UCI has entered 
into a joint services agreement with Autoparts, under which the two companies 
provide certain administrative functions for each other on an arm's length 
basis. Although such efficiency initiatives could produce cost and revenue 
benefits over time for each company, we believe they also include inherent 
execution risks. 

UCI's "fair" business risk profile reflects the strong price and service-based 
competition of the automotive aftermarket and the company's limited revenue 
diversity. Offsetting these difficulties are the relative stability of the 
aftermarket (many parts are not discretionary), the company's leading position 
in certain product categories, and solid double-digit EBITDA margins, which 
the company maintained during the recession because of its market position and 
relatively stable demand. 

We believe that UCI derives about 85%-90% of its revenues from the aftermarket 
(replacement parts for older vehicles) and the balance from the original 
equipment manufacturing and service (OEM/OES) markets (relatively new 
vehicles). In the aftermarket, UCI sells to both traditional channels (the 
do-it-for-me businesses) and retailers (do-it-yourself). We expect that any 
changes to this market mix will evolve slowly over time. We expect ongoing 
challenges in certain segments from competition from parts suppliers in 
low-cost countries, resulting in lower pricing power for U.S. aftermarket 
participants, and softness in miles driven. UCI's earnings are also subject to 
volatility in costs for commodities and energy as well as changes in foreign 
currency exchange rates.

We view the company's financial risk profile as "highly leveraged." For the 
rating, we expect debt to EBITDA of just more than 5x, funds from operations 
(FFO) to total debt just more than 10%, and that cash flow from operations 
will remain positive. As of June 30, 2012, credit metrics were outside of 
these ranges with total debt to EBITDA of 6.8x, FFO to total debt about 6%, 
and negative free cash flow. We estimate that total debt to EBITDA could 
remain above 6x through year-end 2012 and not drop materially in 2013. In 
assessing the financial risk profile, we have taken into account UCI's limited 
financial policy track record under an affiliate of Rank Group, which acquired 
the company in the first quarter of 2011. We include our adjustments for 
lease, pension, and receivables factoring as debt. We view UCI's free cash 
flow generation as low relative to its debt load.

Sales in the U.S. auto aftermarket (excluding tire sales) have historically 
been fairly recession-resilient compared with new-vehicle-related sales and 
have grown by single-digit percentages yearly. However, more recently, 
unemployment remains high, consumer sentiment volatile, and data from the U.S. 
Department of Transportation's Federal Highway Administration indicates that 
the number of miles driven remains less than the 2005 peak. The U.S. recession 
and volatile gas prices caused consumers to drive less and defer discretionary 
maintenance in recent years, whereas in previous years, consumer maintenance 
purchases provided slight revenue growth. Despite a slight increase in miles 
driven and lower gas prices year over year in second-quarter 2012, there was a 
general softness in the aftermarket, which hurt the company's sales. Also, 
miles driven remain below prerecession levels.

UCI's sales are narrowly focused on a few key products: filtration products, 
fuel delivery systems, cooling systems, and vehicle electronics. Customer 
diversity is fair. UCI's largest customer--AutoZone Inc. (BBB/Stable/A-2), the 
nation's largest automotive aftermarket retailer--accounts for about 30% of 
UCI's sales. During the second quarter of 2012, the company lost a customer 
fuel pump business and lost some market share in its water pump business. 

Liquidity
We view UCI's liquidity as "adequate" under our criteria:
     -- We expect UCI's sources of liquidity, including cash and credit 
facility availability, to exceed uses by 1.2x or more over the next 12 to 18 
months.
     -- We expect net sources of liquidity to remain positive, even if EBITDA 
declines more than 15%.
     -- In our opinion, UCI could absorb a low-probability, high-impact market 
or operating shock.
The company has an undrawn $75 million revolving credit line (due January 
2016), with availability reduced by $8 million for letters of credit as of 
June 30, 2012. The company has no material near-term debt maturities. UCI's 
$300 million senior secured term loan facility matures July 26, 2017, and 
amortizes at 1% per year. The company's $400 million 8.625% senior unsecured 
notes mature on Feb. 15, 2019. 

We expect free cash flow from operations after capital spending for 2012 to be 
modestly positive. The company reported it had $66 million in cash as of June 
30, 2012. We assume the company could pursue small bolt-on acquisitions funded 
from internal cash flow. We expect capital expenditures for 2012 to be 
approximately $50 million including approximately $20 million for capital 
investment for long life-cycle OEM contracts launching over the next year.

The company was in compliance with covenants as of June 30, 2012. We believe 
the covenants under the credit agreement provide adequate cushion for a 
shortfall against UCI's financial plan. The senior secured credit facilities 
require UCI to maintain a minimum interest coverage ratio, a maximum senior 
secured leverage ratio, and a maximum level of capital expenditures. 

Recovery analysis
For the latest recovery analysis, please see Standard & Poor's recovery 
report, to be published later on RatingsDirect.

Outlook
The negative outlook on UCI reflects our opinion that the company's adjusted 
leverage could remain above 6x for the year ahead, outside our range of 
expectations for the rating. 

We could lower our ratings within the next year if the company fails to make 
progress in expanding revenues by growing share, or if the economy fails to 
recover, leading to persistently weaker consumer demand or customer resistance 
to commodity cost recovery such that FFO to debt remains less than 10%, debt 
to EBITDA remains near 6x, or the company continues to generate negative cash 
flow. Leveraged distributions to shareholders that would worsen leverage could 
also result in a lower rating.

We could revise our outlook to stable if we believe there is an increased 
likelihood UCI can maintain credit ratios in line with the rating, even if 
demand recovery in its segments remains lackluster in the sluggish economic 
recovery.

Although unlikely within the next year, we could raise our ratings if we raise 
our assessment of the financial risk profile to "aggressive." An upgrade would 
require that we believe UCI would generate meaningful free cash flow to use 
toward debt reduction, resulting in leverage improving to less than 4.5x and 
FFO to debt of more than 12%. This could occur if the gross margin reaches 30% 
or better and revenue growth is 4% or higher in 2012. Gross margin could 
improve if the company is able to successfully integrate certain of its 
filters operations with Autoparts' filter business, an effort that is ongoing. 
We would also need to believe that financial policies under Rank Group would 
support permanent reductions in debt.

Related Criteria And Research
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 
     -- Corporate Criteria: Analytical Methodology, April 15, 2008


Ratings List
Ratings Affirmed; Outlook Action
                                        To                 From
UCI Holdings Ltd.
 Corporate Credit Rating                B/Negative/--      B/Stable/--

Ratings Affirmed

UCI International Inc.
 Senior Secured                         B+                 
  Recovery Rating                       2                  
 Senior Unsecured                       CCC+               
  Recovery Rating                       6                  


 

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below