Fitch Affirms Moody's at 'BBB+'; Outlook Stable
KEY RATING DRIVERS
High Barriers to Entry: MCO's rating segment (Moody's Investors Service; MIS) operates with limited competitive threats as a leading Credit Rating Agency (CRA) with a meaningful and defensible share of the global ratings business. The global scale, significant infrastructure required to comply with increasing regulatory standards and long history of investor acceptance serve as impediments to new entrants. Fitch notes that brand, reputation, and existing coverage are self-reinforcing and generally a prerequisite to win new businesses, creating challenges for other CRAs outside the largest three agencies competing at the regional geographic and niche product levels.
Entrenched Role of NRSROs: Nationally Recognized Statistical Rating Organizations' (NRSRO) ratings are codified within a number of federal and state regulations and statutes and are a critical element for asset managers and financial institutions to meet a variety of legal and regulatory requirements. Dodd Frank removed references to NRSROs in certain regulations in order to reduce the reliance and the required use of NRSROs' credit ratings. However, Fitch believes financial market participants will continue to rely on credit ratings given the absence of viable alternatives. Fitch also believes NRSROs will remain favored by investors compared to unregistered agencies given the more stringent oversight and compliance necessary to meet NRSRO requirements.
Diversification: Fitch notes that MCO's MIS segment is dependent on both dollar volume and number of ratable debt issues, which tend to be closely linked to the health of the major economies as well as government fiscal and monetary policies. MIS generates recurring contractual annual fees to monitor existing ratings, mitigating the more volatile fees from new issuance. As of year-end 2015, approximately 37% of MIS's reported revenue was recurring. Fitch also notes MCO's analytics segment (MA) accounts for more than 15% of MCO's operating income, with more than 70% of MA's sales comprised of recurring revenue in 2015.
Conservative Leverage: MCO continues to target solid investment-grade ratings and historically has maintained Fitch-calculated unadjusted gross leverage around 2x. As of the LTM period ended June 30, 2016, Fitch-calculated leverage was 2.1x and Fitch expects no material change at the end of 2016 barring material acquisitions. Free cash flow (FCF) margin (after dividends) and FCF-to-debt of 20.3% and 20.5%, respectively, are strong for a 'BBB+' rating. There is flexibility to exceed the 2.5x target within the current rating to accommodate potential strategic M&A activity, as Fitch believes MCO can delever within 12-18 months given its FCF margin. While EBITDA margin and FCF generation could support slightly more leverage at the current rating, the regulatory and litigation event risk (discussed below) weighs upon the rating's leverage tolerance.
Share Repurchase and Dividends Growing: Management expects to complete approximately $1 billion in share repurchases in 2016. Dividends have consistently grown at a five-year CAGR of 26% through 2015. Absent large acquisition activity, Fitch expects FCF will continue to be dedicated toward shareholder returns. In addition, Fitch believes management will issue debt to support its capital allocation strategy to the extent leverage remains within the 2x-2.5x range.
Regulatory and Litigation Uncertainty: The ratings recognize several potential overhangs on MCO's credit profile, namely regulatory and litigation-related uncertainties. Fitch believes MCO carries a meaningful level of liquidity, providing financial flexibility to address regulatory and/or litigation risk. In addition, given the time it takes for legal and regulatory matters to be processed (cases can take years before a settlement may be reached), MCO can preserve additional liquidity if it believes a case may result in a material cash payment.
Fitch's key assumptions within the rating case for Moody's include:
--Low - to mid-single-digit revenue growth;
--Stable EBITDA margins;
--Base case assumes that shareholder returns continue in the form of share repurchases and dividends.
Positive: Given the regulatory and litigation risk overhang, Fitch does not expect any positive near-term rating momentum. Fitch would consider an upgrade in the absence of material litigation or regulatory overhang, diversification increasing from MA's subscription revenue growth, and a stated commitment to a leverage target below 1.5x.
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
--Acceleration of regulatory and litigation-related event risks combined with material operating or financial metric deterioration;
--Any debt financing transaction that drove unadjusted gross leverage over 2.5x, without the expectation of delevering below 2.5x within 12 to 18 months.
Moody's liquidity is strong and supported by approximately $400 million of readily available cash and short-term investments as of June 30, 2016, $1 billion in revolving credit facilities (all of which was available as of June 30, 2016) and expected FCF generation. MCO's revolver, which provides liquidity backup to its $1 billion CP program, matures in May 2020. Scheduled maturities are well-laddered and manageable considering that expected FCF generation, reliable market access and backup liquidity all add to Moody's overall financial flexibility. Moody's next scheduled maturity is not until 2017 when $300 million of unsecured notes come due.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-Term IDR at 'BBB+';
--Short-Term IDR at 'F2';
--Senior unsecured revolving credit facility at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Commercial paper at 'F2'.