Fitch Affirms Tenneco's IDR at 'BB+'; Outlook Stable
KEY RATING DRIVERS
TEN's ratings continue to be supported by the company's market position as a top global supplier of emission control and vehicle suspension components, with a strong presence in both the original equipment and aftermarket segments. Fitch expects demand for TEN's Clean Air products to remain strong over the intermediate term as global emissions requirements for light vehicles continue to tighten. In addition, more restrictive global regulations governing commercial truck and off-highway vehicle emissions is leading to enhanced growth opportunities and higher profitability as the larger engines in these vehicles require more emissions-related content. New technologies in the company's Ride Performance division, including increased production of electronic suspension systems, will also contribute to revenue and profitability growth, although Fitch expects emissions control products to be a larger contributor to TEN's sales growth over the intermediate term. Fitch expects intermediate term growth in profitability and FCF will provide the company with continued financial flexibility.
Primary risks to the company's credit profile include industry cyclicality, volatile raw material costs and variability in fuel prices. Cyclical risk is mitigated somewhat by the increasing diversification of the company's book of business and its improving cost structure, as well as the ever-tightening global emissions regulations, which will drive growth in the market for emission control products independent of global economic conditions. Also mitigating risk and supporting near-term liquidity is a lack of material debt maturities until 2019. Volatile fuel prices present a risk because the company's content on smaller and more fuel efficient vehicles tends to be less profitable. As with other auto suppliers, TEN seeks to minimize the effect of volatility in raw material prices by passing along a substantial portion of the change in its material costs to its original equipment customers. In addition, reflecting the strengthening of its balance sheet in recent years, the company has indicated the potential for opportunities that would enhance its business through acquisitions, which could run the risk of at least a temporary increase in leverage.
Another notable risk is the potential for an adverse outcome in the ongoing antitrust investigation of TEN being conducted by the European Commission (EC) and the U. S. Department of Justice (DOJ). Details of the investigation, the potential timing of any resolution and the ultimate exposure to TEN are currently unknown, but the DOJ's willingness in 2014 to grant the company conditional leniency through the Antitrust Division's Corporate Leniency Policy is encouraging. The Leniency Policy limits TEN's exposure as long as the company self - reports matters to the DOJ and continues to cooperate with the DOJ's investigation. Nonetheless, a particularly adverse outcome from the investigation by either the EC or the DOJ could lead to a negative rating action.
Fitch expects the higher margins generated by TEN's commercial and off-highway business to combine with improvements in the company's cost structure to support further margin growth over the intermediate term. Fitch's calculated EBITDA margin was 9.2% in latest-12-months (LTM) ended June 30, 2016, but excluding substrate sales, which are primarily related to precious metals used in emission control systems and are largely passed through to the company's customers with little mark-up, the EBITDA margin would have been a relatively strong 12.1% for the period. In the LTM ended June 30, 2016, substrate pass-through revenue totaled $2.0 billion, or 24%, of the company's $8.4 billion in total revenue. Since larger engines require more substrates in their emissions control systems, substrate pass-through revenue is likely to increase as a percentage of the company's overall revenue over the intermediate term. This likely will result in some margin dilution that could mask some of the increased profitability associated with emissions control products for larger engines.
Fitch expects TEN to produce positive FCF over the intermediate term, with FCF margins generally running in the low-single digit range. Fitch expects capital spending as a percentage of revenue to run at about 3.5% over the intermediate term, which is generally in line with historical levels. FCF in the LTM ended June 30, 2016, was $185 million, equal to a 2.2% FCF margin. Fitch's FCF calculation excludes the effect of period-to-period changes in off-balance sheet factored receivables, which Fitch treats as a change in financing cash flows. Fitch expects TEN's FCF margin to run in the low-1% range for the full year 2016, down from 1.7% in 2015, as a result of higher capital spending and increased cash taxes. Capital spending is expected to be elevated in 2016 as a result of a specific customer program on an accelerated development schedule. Fitch expects TEN's value-added FCF margin, excluding estimated substrate sales, to be closer to 1.5x in 2016, and rising to the low-2x range over the intermediate term.
Fitch expects TEN's EBITDA leverage, including off-balance sheet factoring, to decline over the next several years, likely to the mid-1x range, as EBITDA grows on higher business levels. Fitch expects lease-adjusted EBITDAR leverage to run near 2x over the intermediate term, while funds from operations (FFO) adjusted leverage is likely to run closer to 3x. Fitch expects total debt levels to remain roughly flat over the intermediate term at about $1.5 billion. As of June 30, 2016, TEN's actual EBITDA leverage (debt/Fitch-calculated LTM EBITDA) was 2.1x, lease adjusted EBITDAR leverage was 2.5x and FFO adjusted leverage was 2.8x. However, the June 30, 2016 figures were somewhat elevated, as the company still had $175 million of its notes due 2020 outstanding. Those notes were redeemed in July 2016. Fitch expects EBITDA leverage to decline to the high-1x range and lease-adjusted EBITDAR leverage to decline to the low-2x range by year end 2016. Fitch expects FFO adjusted leverage to remain near 3x at year end 2016.
Fitch expects TEN's liquidity to remain adequate over the intermediate term. At June 30, 2016, TEN had $311 million in unrestricted cash and cash equivalents, but nearly all of this was located outside the U. S. However, Fitch expects the company will continue to repatriate cash from outside the U. S. at a level sufficient to cover most of its U. S. cash needs that are not covered by cash generated in the U. S. In addition to its cash, TEN had $1.1 billion in availability on its $1.2 billion secured revolver, after accounting for $107 million in outstanding borrowings.
Fitch expects TEN's FFO fixed charge coverage to run in the high-4x to low-5x range over the intermediate term as a result of increased FFO on higher business levels and increased profitability. Actual FFO fixed charge coverage at June 30, 2016 was 5.1x. Fitch expects EBITDA interest coverage (LTM EBITDA/gross interest expense) to also increase as a function of higher EBITDA. As of June 30, 2016, TEN's actual EBITDA interest coverage was 9.3x, and Fitch expects it could rise into the low-teens over the next couple of years.
TEN's pension plans remain adequately funded. At year-end 2015, the company's U. S. plans were 73% funded, with an unfunded status of $114 million. TEN's non-U. S. plans were 84% funded, with an unfunded status of only $68 million. TEN contributed $9 million to its U. S. plans and $16 million to its non-U. S. plans in2015. The company contributed $8 million to its global plans in the first half of 2016, and it expects to have about $36 million in required contributions over the remainder of the year. The required contributions in the second half of 2016 will include contributions related to a buyout offered to certain active and retired employees. Fitch views the funded status and required contributions related to TEN's plans to be manageable, given the company's liquidity and FCF prospects.
TEN's secured revolver and secured Term Loan A both have a recovery rating of 'RR1' and are rated one-notch above the company's Long-Term IDR, reflecting their substantial collateral coverage, which includes virtually all of the company's U. S. assets and up to 66% of the stock of its first-tier foreign subsidiaries. Based on Fitch's recovery rating criteria, 'BBB-' is the highest issue rating that may be assigned to an issuer with an IDR of 'BB+' or lower. Fitch has assigned a recovery rating of 'RR4' to TEN's senior unsecured notes, reflecting Fitch's expectations for an average recovery in a distressed scenario.
--U. S. light vehicle sales run in the low - to mid-17 million range in 2016 and global sales rise in the low-single digit range;
--After 2016, U. S. industry sales plateau at around 17 million, while global sales continue to rise modestly in the low-single digit range;
--Debt, including off-balance sheet securitizations, remains steady around $1.5 billion over the next several years;
--Capital spending is elevated in 2016 due to a specific new customer program on an accelerated development schedule, and beyond 2016 capital spending runs at about 3.5% of revenue;
--The company keeps between $250 million and $300 million in consolidated cash on hand, with any excess cash used for acquisitions or share repurchases;
--The company completes its $350 million share repurchase program by year-end 2017.
Positive: Further developments that may, individually or collectively, lead to a positive rating action include:
--An Increase in TEN's value-added free cash flow margin to about 3% on a consistent basis;
--A decline in FFO adjusted leverage to 2.5x or lower;
--An increase in FFO fixed charge coverage to 5x or higher.
Negative: Further developments that may, individually or collectively, lead to a negative rating action include:
--A severe decline in global vehicle production that leads to reduced demand for TEN's products;
--A decline in TEN's value-added free cash flow margin to below 1% for an extended period;
--An increase in FFO adjusted leverage to 4x or higher;
--A decline in FFO fixed charge coverage to 3x or lower;
--An adverse outcome from the antitrust investigation that lead to a significant decline in liquidity or an increase in leverage.
Fitch has affirmed the following ratings with a Stable Rating Outlook:
--Long-Term IDR at 'BB+';
--Secured revolving credit facility at 'BBB-/RR1';
--Secured Term Loan A rating at 'BBB-/RR1';
--Senior unsecured notes rating at 'BB+/RR4'.