Fitch Upgrades American Axle's IDR to 'BB'; Outlook Stable
AAM's ratings apply to a $523.5 million secured revolving credit facility and $1.35 billion in senior unsecured notes. The Rating Outlooks for both AXL and AAM are Stable.
KEY RATING DRIVERS
The upgrade of the IDRs for both AXL and AAM is driven by improvement in the company's credit metrics, consistently solid FCF generation and increased customer, product and geographical diversification. Although the company remains heavily reliant on General Motors Company's (GM) full-size truck program, it continues to add new business with a variety of U. S., European and Asian auto manufacturers, and 60% of its new business backlog over the 2016 to 2018 time frame is for customers other than GM. This increased diversification has been partly driven by AXL's EcoTrac disconnecting all-wheel drive system, which was initially offered on two Fiat Chrysler Automobiles NV (FCA) platforms, but will be offered on several other auto manufacturers' platforms over the next several years. AXL also continues to invest in other new technologies, such as its e-AAM electronic drive system, which will give it more exposure to the growing hybrid and electric vehicle markets, and its QUANTUM lightweight axle components.
Fitch's concerns include the continued concentration of AXL's revenue base, despite its enhanced diversification; heavy competition in the light vehicle driveline market; the loss of a portion of its content on the next full-size GM truck platform; and the sensitivity of the company's credit metrics to changes in its operating performance. Although AXL will continue to diversify its book of business over the intermediate term, GM is likely to remain the company's largest customer by a wide margin for a number of years, with GM's full-size truck platform contributing substantially to the company's results. Fitch expects competition in the light-vehicle driveline market to remain heavy over the coming years, especially as AXL attempts to gain a foothold with auto manufacturers it has not worked with before. Other, larger suppliers also offer similar driveline technologies that offer some of the same benefits of those being marketed by AXL. The company has also shown in the past that its credit metrics can deteriorate quickly in the event of a decline in its operating performance.
In 2015, AXL was selected as a target supplier under GM's Strategic Sourcing Program (SSP) to provide axles and driveline equipment for future generations of GM's full-size light truck and SUV program, potentially locking in AXL on the program for more than a decade. However, in conjunction with achieving target supplier status, AXL expects that GM will procure 25% of AXL's current content from other sources. Fitch views the loss of this high-margin business as a credit negative and estimates that the content that will be lost accounted for roughly 12% to 13% of AXL's revenue base in 2015. Fitch expects that AXL will not see any effect of this lost business for at least two years, giving the company time to reallocate the capacity to other programs. As of June 30, 2016, AXL had secured new future business sufficient to replace 60% of what it expects lose from the GM light truck program. Fitch believes the company has the ability to replace more of the lost business, but the new programs are likely to carry lower margins, given the significant scale efficiencies that AXL realizes on the GM full-size light truck program.
Since the last recession, AXL has primarily targeted its cash deployment toward organic business investments and strengthening its balance sheet. With a stronger balance sheet, and with the company producing solid FCF on a consistent basis, it has broadened its cash deployment plans. In May 2016, AXL announced a relatively modest $100 million share repurchase program that runs through year-end 2018, and the company has begun to consider the possibility of inorganic growth opportunities. Fitch expects the share repurchase program will be funded with FCF, with no impact on long-term debt, and that the company would slow repurchase activities if it needed to conserve cash. As of June 30, 2016, AXL had spent only $1.5 million on share repurchases under the program. The effect of an acquisition on AXL's credit metrics would depend on the size of the transaction and the amount of any incremental debt, but after an acquisition the company would likely focus on reducing incremental leverage resulting from the acquisition.
Fitch expects AXL to produce solidly positive FCF over the intermediate term, with FCF margins generally running in the low - to mid-single digit range. Fitch expects capital spending as a percentage of revenue to run at about 5% over the intermediate term, although it is likely to run closer to 6% in 2016 due to new projects coming on line within the next year. FCF in the LTM ended June 30, 2016 was $199 million, equal to a 5.1% FCF margin, supported, in part, by strong production volumes in GM's full-size light truck program. Fitch expects AXL's FCF margin to run in the low-3% range for the full year 2016, down from 4.7% in 2015, primarily as a result of the higher capital spending.
Fitch expects AXL's EBITDA leverage to run in the low - to mid-2x range over the next several years, primarily as a function of changes in EBITDA. Debt is likely to remain near the current $1.4 billion level, as the company has no significant debt maturities until 2019, although its secured revolver comes due in 2018. Fitch expects lease-adjusted EBITDAR leverage to run in the mid-2x over the intermediate term, while funds from operations (FFO) adjusted leverage is likely to run closer to the mid - to high-2x range. As of June 30, 2016, AXL's actual EBITDA leverage (debt/Fitch-calculated LTM EBITDA) was 2.3x, lease adjusted EBITDAR leverage was 2.6x and FFO adjusted leverage was 3.2x.
Fitch expects AXL's liquidity to remain adequate over the intermediate term. At June 30, 2016, AXL had $388 million in unrestricted cash and cash equivalents, augmented by $513 million of availability on its secured revolver (after accounting for about $10 million in letters of credit backed by the facility). Fitch estimates that about 56% of the company's unrestricted cash and cash equivalents was located outside the U. S.
AXL's pension plans remain relatively well funded. At year-end 2015, the company's plans were 88% funded, with an unfunded status of $80 million. The company contributed $20 million to its pension plans in 2015. Due to prefunding balances, AXL has no required plan contributions in 2016, although it could make voluntary contributions to the plans. Given AXL's liquidity and FCF prospects, Fitch does not view the company's pension plans as a meaningful credit risk.
The Recovery Rating of 'RR1' assigned to AAM's secured revolving credit facility reflects its collateral coverage, which includes virtually all the assets of AXL and AAM, leading to expected recovery prospects in the 90% to 100% range in a distressed scenario. The Recovery Rating of 'RR4' assigned to AAM's senior unsecured notes reflects Fitch's expectation that recovery prospects would be average, in the 30% to 50% range, 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;
--Over the longer term, the company replaces the lost GM light truck business with new business at a lower margin;
--Debt remains steady around $1.4 billion over the next several years;
--Capital spending runs at about 6% of revenue in 2016 due to a program coming on line over the next year, and beyond 2016 capital spending runs at about 5% of revenue;
--The company keeps between $250 million and $300 million in consolidated cash on hand, with any excess cash used for share repurchases or, potentially, an acquisition;
--The company completes its $100 million share repurchase program by year-end 2018.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Continued progress on diversifying the company's revenue base;
--Sustained FCF margins of 3.5% or higher;
--Sustained EBITDA leverage in the low - 2x range;
--Sustained FFO adjusted leverage in the mid - 2x range;
--Successfully replacing the lost 25% of the GM full-size light truck and SUV revenue with new business.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Significant production inefficiencies and associated cash burn tied to the start-up of new programs;
--A rise in EBITDA leverage to above 3x for a sustained period;
--A rise in FFO adjusted leverage to 3.5x or higher for a sustained period;
--A sustained decline in the EBITDA margin to below 10%;
--Sustained FCF margins below 2%;
--A prolonged disruption in the production of GM's full-size pickups and SUVs.
Fitch has taken the following rating actions on AXL and AAM:
--IDR upgraded to 'BB' from 'BB-'.
--IDR upgraded to 'BB' from 'BB-';
--Secured revolving credit facility rating affirmed at 'BB+/RR1';
--Senior unsecured notes rating upgraded to 'BB/RR4' at 'BB-/RR4'.
The Rating Outlook is Stable.