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Fitch Affirms BorgWarner's IDR at 'BBB+'; Outlook Stable
September 27, 2017 / 2:40 PM / 21 days ago

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

(The following statement was released by the rating agency) CHICAGO, September 27 (Fitch) 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. BWA's ratings apply to a $1.2 billion unsecured revolving credit facility, $2.1 billion in senior unsecured notes and a $1.2 billion CP program. The Rating Outlook 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 the company's 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) significantly enhanced its technology offerings for electric and hybrid vehicles. Fitch's rating concerns continue to include BWA's active interest in acquisitions, which could result in periodic increased leverage, and its ongoing focus on shareholder-friendly activities. BWA recently agreed to acquire Sevcon, Inc. (SEV) for an enterprise value of about $200 million, and Fitch expects the company will likely make other acquisitions over the longer term. Fitch expects most acquisitions will be roughly the size of the SEV acquisition or smaller and funded with temporary borrowings, as opposed to its relatively large REMY acquisition in 2015, which was partially funded with incremental long-term debt. Nonetheless, Fitch expects the company would consider a larger debt-funded acquisition under the right circumstances. In early 2015, BWA launched a $1 billion three-year share repurchase program. It spent $350 million on share repurchases in 2015, and $288 million on share repurchases in 2016. However, the company expects to repurchase only about $100 million in shares in 2017, a more restrained amount than in the prior two years, as it focuses on funding the SEV acquisition. Common stock dividends totaled $113 million in 2016 and $59 million in the first half of 2017. Fitch's concerns regarding acquisitions and shareholder-friendly activities are offset somewhat by the company's consistently positive FCF generation. The large proportion of BWA's consolidated cash that is located outside the U.S is an additional rating concern. At June 30, 2017, only $5.3 million of the company's $387 million cash balance was located in the U.S. Although the company maintains significant cash balances outside the U.S. to fund its sizeable non-U.S. operations (75% of its revenue in 2016 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. To help diversify its funding sources, BWA issued EUR500 million in senior unsecured notes in 2015, proceeds from which were used to fund part of the REMY acquisition. Absent any debt-funded acquisitions, Fitch expects BWA's EBITDA leverage to decline to the low-1x range over the intermediate term as the company works to lower its net debt to net capital ratio back to its target range of 15% to 30%. As of June 30, 2017, BWA's actual net debt to net capital ratio (based on BWA's calculation) was 33.2%, still outside its target range but down from 35% at year-end 2017. BWA's EBITDA leverage, based on Fitch's calculation, was 1.4x and FFO adjusted leverage was 2.1x at June 30, 2017. Leverage had previously been elevated as a result of the REMY acquisition in 2015. However, the company repaid $150 million in notes at maturity in 2016, and its off-balance sheet factoring program, which Fitch treated as debt, was divested along with REMY's former light vehicle aftermarket business in 2016. Fitch estimates that roughly $100 million of off-balance sheet factoring had been outstanding. Near-term debt maturities are manageable. In addition to $20 million in commercial paper borrowings at June 30, 2017, BWA had $105 million in other short-term debt and $17 million in current maturities of long term debt. Fitch expects that CP borrowings will continue to vary with the company's cash needs, while other short-term borrowings are likely to be largely refinanced. 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. BWA has no material debt maturities coming due until October 2019, when its $134 million in 8% 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. Fitch expects capital spending to generally run at about 5.5% to 6% of revenue over the intermediate term. Fitch expects the effect of share repurchases to largely offset the effect of any dividend increases 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, 2017 was $406 million, equal to a 4.4% FCF margin. Fitch expects BWA's FCF margin will run in the 4% to 4.5% range for the full-year 2017 and for the next several years, with FCF margins approaching 5% over the longer term. Fitch expects BWA's liquidity to remain adequate over the intermediate term. At June 30, 2017, BWA had $387 million in consolidated cash and cash equivalents, but only 1.4% of this was located in the U.S. Nonetheless, Fitch expects the company will repatriate cash from outside the U.S. at a level sufficient to cover most of its domestic liquidity needs not covered by U.S.-generated cash. In addition to its cash, BWA had nearly full availability on its $1.2 billion unsecured revolver at June 30, 2017 after accounting for $20 million in outstanding CP backed by the facility. BWA's pension plans remain relatively well funded, and all of BWA's U.S. plans are closed to new entrants. At year-end 2016, the company's U.S. plans were 81% funded, with an underfunded status of only $53 million. The company also sponsors defined benefit plans in certain countries outside the U.S., some of which are generally unfunded. BWA contributed $2.7 million to its U.S. plans and $17 million to its non-U.S. plans in 2016. In aggregate, the company's non-U.S. plans were 75% funded at year-end 2016, with an underfunded position of $134 million. The company expects to contribute between $15 million and $25 million to its global plans in 2017, including $3.2 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 in the U.S., Fitch does not currently view BWA's pension plans as a meaningful credit risk. DERIVATION SUMMARY BWA has a relatively strong competitive position focusing on automotive powertrain and drivetrain technologies that are likely to grow in demand over the longer term as auto manufacturers increasingly focus on ways to make vehicles more fuel efficient. The company's product offerings were bolstered by its 2015 acquisition of REMY, which significantly increased BWA's technologies for hybrid and electric vehicles. That being said, compared with certain automotive technology suppliers, such as Delphi Automotive PLC (BBB/Stable) or Visteon Corporation (Not Rated), which are increasingly focused on in-car advanced technologies, BWA is dedicated to technologies related to vehicles' motive power. BWA also competes with a number of large global suppliers, such as Continental AG (BBB+/Stable) and ZF Friedrichshafen AG (NR), which provide powertrain and drivetrain products, as well as other advanced vehicle technologies. BWA's margins are among the strongest of the global auto suppliers, largely due to its focus on higher-value-added powertrain and drivetrain technologies and its relatively low-cost production footprint. However, from a size perspective, it is more mid-pack, with less than one-third the revenue of the largest players, such as Continental, Magna International Inc. (NR) or Robert Bosch GmbH (F2). BWA's credit protection metrics are on the stronger end of auto suppliers in the 'BBB' category, such as Delphi or Lear Corporation (bbb-*/Positive*). KEY ASSUMPTIONS Fitch's key assumptions within its rating case for the issuer include: --Low-single-digit global auto production growth over the intermediate term; --New business wins and increased penetration rates result in organic revenue growth exceeding global light vehicle production growth; --Capital spending runs between 5.5% and 6% over revenue over the next several years; --The common stock dividend rate rises over time, but total cash spent on dividends is about flat as stock buybacks reduce the share count; --The company makes modest to moderately sized acquisitions from time to time; --The company generally maintains about $400 million to $500 million in cash, with excess cash used for acquisitions or share repurchases. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action 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. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --An unexpected sharp drop in global auto production; --A change in financial policy that results in leverage rising to above 1.5x for a prolonged period; --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 repatriation of non-U.S. cash. LIQUIDITY Fitch expects BWA's liquidity to remain adequate over the intermediate term. At June 30, 2017, BWA had $387 million in consolidated cash and cash equivalents, but only 1.4% of this was located in the U.S. Nonetheless, Fitch expects the company will repatriate cash from outside the U.S. at a level sufficient to cover most of its domestic liquidity needs not covered by cash generated in the U.S. In addition to its cash, BWA had nearly full availability on its $1.2 billion unsecured revolver after accounting for $20 million in outstanding CP backed by the facility. Based on its criteria, Fitch treats non-U.S. cash, as well as and cash needed to cover seasonal needs and other obligations, as "not readily available" for purposes of calculating net metrics. Due to the substantial portion of BWA's consolidated cash that is outside the U.S., along with the seasonality in its business, Fitch has treated all of BWA's consolidated cash at June 30, 2017 as not readily available. However, as noted above, Fitch believes the company has sufficient financial flexibility to meet its intermediate-term cash obligations. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings with a Stable Outlook: BorgWarner Inc. --Long-Term Issuer Default Rating (IDR) at 'BBB+'; --Short-Term IDR at 'F2' ; --Unsecured revolving credit facility at 'BBB+'; --Senior unsecured notes at 'BBB+'; --Commercial paper at 'F2'. Contact: Primary Analyst Stephen Brown Senior Director +1-312-368-3139 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Craig D. Fraser Managing Director +1-212-908-0310 Committee Chairperson Mark Sadeghian, CFA Senior Director +1-312-368-2090 Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings. 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. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) 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. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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