Fitch Affirms Trinity's IDR at 'BBB-'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) for Trinity Industries, Inc. (Trinity) at 'BBB-'. In addition, Fitch has affirmed the senior unsecured revolving credit facility at 'BBB-' and Trinity's subordinated convertible notes at 'BB+'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The affirmation takes into account Trinity's sizable cash balances and overall liquidity in the face of a substantial downturn in railcar demand. A slowdown in railcar deliveries as well as weakness in the inland barge business is expected to materially constrain Trinity's operating results over the next 1-2 years. In addition, Trinity faces the potential for a sizable payout related to ongoing guard rail litigation. These factors are balanced against Trinity's moderate financial leverage, solid financial flexibility, and leading industry positions in a majority of its business lines.
Trinity has a substantial railcar leasing business which broadens the company's industry presence and scale and helps to mitigate the impact of cyclicality at the railcar and other manufacturing operations. Fitch's assessment of Trinity's manufacturing businesses considers Trinity Industries Leasing Company (TILC) on an equity basis.
End-market weakness is constraining demand in Trinity's manufacturing operations, and particularly in the rail and inland barge segments, both of which could see sales declines of 30% or more in 2016. In addition, the energy equipment segment is expected to see lower sales, while the construction products group is expected to see modest sales growth.
The rail group, which accounts for around 60% of sales within the manufacturing segment, is the key area of weakness. A sharp drop in new railcar orders in 2016, particularly oil and gas tank cars, will be partially mitigated over the near term by a sizable backlog, which as of the end of March 2016 totalled approximately 43,000 railcars. The backlog is valued at approximately $4.7 billion, including $1.3 billion for the leasing group. The company expects to deliver 27,000 railcars in 2016, about 7,000 cars less than 2015, with the bulk of the orders coming from the backlog. Fitch expects industry weakness will persist in 2017 with the potential for a recovery in 2018.
Guard Rail Litigation
Guard rail litigation represents a significant rating concern following an award against Trinity in October 2014 under the federal False Claims Act. The final judgment against the company was $682.4 million, against which Trinity posted a $686 million bond. In August 2015, the company filed an appeal with the U.S. Court of Appeals for the Fifth Circuit and a final judgment is not expected before late 2016, which could be followed by additional appeals. There are also a number of state cases that are currently stayed pending resolution of the appeal, as well as a number of product liability and class action lawsuits, which could represent a substantial additional liability.
Fitch expects Trinity would have sufficient cash liquidity to cover the False Claims Act judgment if necessary. Should incremental borrowing be required, Fitch would consider a negative rating action, particularly if it occurs during a period of cyclical weakness as is expected over the next 1-2 years. The revolver and warehouse facility have language that permits the lenders to not fund this payment. However, a lengthy appeals process will give management time to address this issue with a lending group that has been supportive of the company through cycles. Trinity's guard rail sales are a relatively small portion of total revenue, so the impact of the litigation on its operations is not significant.
Weaker Credit Metrics
Fitch expects debt/EBITDA for the manufacturing operations will increase from 0.9x at the end of 2015 to around 1.9x at the end of 2016, and into the low-2x range in 2017, on flat debt levels and lower EBITDA. Leverage is expected to improve gradually thereafter. EBITDA/interest remains healthy, in excess of 10x. This outlook does not incorporate incremental borrowing that would be required to fund the guard rail litigation judgment, the ultimate outcome of which is uncertain. The current rating contemplates mid-cycle leverage (gross manufacturing debt/manufacturing EBITDA) of approximately 1.0x - 1.5x, giving Trinity the flexibility to adjust to downturns in its cyclical end markets.
Improving Cash Flow
Fitch estimates manufacturing free cash flow (FCF) will improve in 2016 to around $400 million from around $253 million in 2015 due to the benefit of lower sales on working capital and lower tax payments due to bonus depreciation rules enacted in December 2015. Manufacturing capital expenditures are estimated by Trinity at $150 million - $200 million in 2016. FCF is expected to remain healthy in 2017 but decline fairly quickly as the business improves and inventories are rebuilt, which is assumed to happen in 2018.
This FCF estimate excludes cash flow from TILC, which varies widely depending on the level of net investment in railcars. The company projects net investment in railcars of $500 million - $600 million in 2016, which is higher than in 2015 due to lower sales of leased railcars, estimated by management at $300 million - $400 million.
Management intends to deploy part of its FCF for share repurchases under a $250 million share repurchase program authorized in December 2015, to cover 2016-2017. In addition, the company makes periodic acquisitions, most of which are relatively small, at less than $100 million. Fitch notes that ongoing share repurchases together with acquisitions could limit the company's ability to accumulate sufficient cash in advance of a possible adverse judgment in the guard rail litigation.
The relationship between Trinity and TILC is an important rating consideration. Fitch views TILC as a core part of Trinity's railcar business reflecting strong operational and financial linkages between the two companies. TILC generates railcar orders for Trinity as it obtains lease commitments, and reduces Trinity's overall cyclicality by providing a relatively stable source of earnings. In addition, TILC increases Trinity's presence in the railcar market by providing customers with a single source for purchasing and financing railcars.
TILC's credit profile is characterized by its good asset quality, solid liquidity and low leverage. Its operating performance is expected to weaken modestly in 2016, driven by moderately lower leasing income and reduced asset sales gains. TILC performed relatively well during the previous downturn including low write-offs and the ability to remarket railcars within the fleet.
TILC finances its railcar assets on a nonrecourse basis through a $1 billion warehouse facility and term securitizations. In addition, TILC has additional unencumbered railcar assets which could provide additional sources of liquidity in the event of market stress. TILC bears modest residual risk on its operating leases, which is offset by its reasonable depreciation policies and the long economic life of the railcars. TILC's heavy reliance on secured, wholesale funding represents a moderate constraint.
TILC does not benefit from a formal support agreement from Trinity, although Fitch believes Trinity would support TILC because of TILC's important role in supporting its parent's railcar business. An important rating consideration is Trinity's ability to maintain a strong balance sheet that reduces risks related to potential disruptions to TILC's funding sources or an unexpected decline in the credit quality of TILC's lease portfolio.
Fitch's key assumptions within the rating case for Trinity's manufacturing operations, including TILC on an equity basis, include:
-- Revenues decline by around 28% in 2016 and 18% in 2017 as railcar and barge demand declines.
-- EBITDA margins narrow by more than 600bps in 2016 due to lower sales, a mix change to lower priced cars, pricing pressures, and negative operating leverage. Margins are assumed to be relatively steady in 2017.
-- FCF improves in 2016 to around $400 million from around $253 million in 2015 due to the benefit of lower sales on working capital and lower tax payments due to bonus depreciation rules enacted in December 2015. FCF remains healthy in 2017 but declines fairly quickly as the business improves and inventories are rebuilt, which is assumed to happen in 2018.
-- Debt levels are assumed to be flat.
-- Debt/EBITDA increases from 0.9x at the end of 2015 to around 1.9x at the end of 2016, and into the low-2x range in 2017, before improving gradually thereafter.
Future developments that may, individually or collectively, lead to a negative rating action include:
--The company loses the guard rail litigation on appeal, resulting in higher debt and leverage;
--Mid-cycle manufacturing debt/EBITDA above 1.0x - 1.5x and above 3.0x through a downturn;
--A material increase in leverage at TILC compared to year-end 2015 levels;
--Large debt-funded acquisitions and/or share repurchases;
--EBITDA margins for the manufacturing segment decline to 10% or lower on a sustained basis;
--Substantial support is required for TILC.
An upgrade is unlikely in the medium term based on the cyclicality of Trinity's manufacturing business and potential funding and credit risk at TILC.
Trinity had healthy liquidity totalling $2.1 billion as of March 31, 2016. Corporate had $636 million in cash and $200 million in total marketable securities as well as a $600 million revolver which had $507 million available after $93 million of letters of credits. The bulk of the cash is in excess of the company's operating needs, which Fitch estimates at $150 million - $200 million for its manufacturing business. The corporate maturity schedule is favorable with the revolver as the nearest maturity in May 2020. Overseas cash is immaterial.
Trinity faces a contingent liability with respect to its $450 million of convertible subordinated notes due in 2036, which are puttable on June 1, 2018. Fitch believes Trinity would have sufficient liquidity between its excess cash and borrowing facilities to handle this liability, should it be necessary.
TILC uses a $1 billion warehouse facility expiring in April 2018 ($741 million was available as of March 31, 2016) and intercompany loans to fund railcar purchases on an interim basis until permanent funding is obtained from securitizations or sales to investment vehicles (RIVs). Trinity does not have a legal obligation to repay TILC's non-recourse debt, but Fitch expects the parent would support TILC if necessary.
Fitch affirms Trinity's ratings as follows:
--Long-term IDR at 'BBB-';
--Senior unsecured revolving credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'
--Subordinated convertible notes at 'BB+'
The Rating Outlook is Stable.