Fitch Affirms Michelin at 'A-'; Outlook Stable.
Fitch has also assigned a long-term senior unsecured rating of 'A-' to Michelin's issue of USD600 milion zero coupon cash-settled convertible bonds due 2023.
The long-term senior unsecured ratings of Michelin, CFM and Michelin Luxembourg SCS are affirmed at 'A-'. CFM is the group's finance arm and the intermediate holding entity for Michelin's non-domestic operations. Fitch has also affirmed Michelin's and CFM's Short-Term IDRs as well as Michelin's and Michelin Luxembourg SCS's short-term debt at 'F2'.
The ratings reflect Michelin's solid and defensive business profile and Fitch's expectations that the group's financial metrics will improve in the foreseeable future. The acquisitions announced in 2018 will stretch credit ratios, including leverage increasing above Fitch's negative rating guideline at end-2018.
However, Fitch believes that the deterioration will only be temporary and projects a rapid return of credit metrics to levels more commensurate with the ratings due to the group's solid cash generation. We also believe that the transitory weakening of the financial structure is offset by Michelin's excellent integration track record and our view that these acquisitions will reinforce the group's positioning and business profile.
KEY RATING DRIVERS
Defensive and Premium Positioning: Michelin derives a majority of its sales from the replacement market, which is more stable and profitable than the original equipment business. In addition, a large part of the revenue comes from the premium tyre segment, which is traditionally higher-margin and faster-growing than the overall market. Geographic diversification is also gradually increasing as a result of Michelin's bold investments in emerging markets.
Supportive Industry Trends: Increased regulatory pressure on car manufacturers to lower emissions and continuous demand from consumers for greater fuel efficiency offer solid prospects for some automotive suppliers, including tire manufacturers, who are able to come up with solutions. The anticipated increase in electric vehicles will also lead to additional growth from new products, notably for Michelin, which has already positioned itself well for this trend with specific tires. Longer-term, the expected penetration of autonomous vehicles will accelerate tire turnover due to greater use of vehicles.
Free Cash Flow Weak but Stable: Michelin's free cash flow (FCF) margin has been rather low for the ratings, at less than 2% on average over the past 10 years. This is because robust underlying funds from operations (FFO) have been largely absorbed by ambitious capex, earmarked chiefly to finance growth in emerging markets, and a generous shareholder payout ratio. Equity-friendly actions have included an active share buy-back programme (recorded below FCF in the cash flow statements), which weigh on net cash generation.
However, earnings and FCF held up during the economic recession and auto industry crisis in 2008-2009, and Fitch expects they will be maintained at current levels. We also acknowledge Michelin's solid cash generation, excluding the effects from commodity prices on inventory. We project the FCF margin to decline to just below 1.5% in 2018 from 2.2% in 2017, but to rebound in 2019-2020 to between 2.5% and 3.5%.
Acquisitions Weaken Credit Metrics Temporarily: Michelin announced a few major transactions in 2018, including Camso, Fenner PLC and the creation of a JV with Sumitomo in the US. This will lead to a total cash outflow of about EUR3.3 billion and will stretch credit metrics, in particular at end-2018, as the group will not consolidate a complete year of sales and earnings of the acquired entities. However, Fitch projects a rapid return of credit ratios to levels more commensurate with the ratings and believes that the temporary weakening of the financial structure is offset by the excellent integration track record of Michelin and its consistent strategy of expanding beyond the core tire manufacturing business and strengthening market positions.
Robust Performance: Michelin maintained solid profitability in 2017 at 12.5%, despite substantially adverse effects from raw material prices and currency movements. Reported profitability is below that of several close peers' as the margins of Michelin are hindered by its cost structure and the bias of its production base towards France and the rest of Europe compared with other peers, as well as overcapacity issues in several plants. However, it has a proven capacity to offset foreign exchange and raw material prices developments with price increases.
Measures to Boost Profitability: The group has restructured operations to streamline its cost base and we believe that profitability will remain solid in coming years. We expect a gradual increase in the operating margin towards 13.5% by 2020 due to additional cost savings, productivity gains, production reorganisation and price increases. These should offset unfavourable raw material prices, possible adverse foreign exchange movements and cost inflation as well as higher depreciation and amortisation following a substantial increase in capex in recent years.
Raw Materials, Currency Exposure: Michelin has a high exposure to foreign exchange due to currency translation risks and the difficulty in perfectly matching production and sales. In addition, raw materials are a major part of Michelin's cost structure and their historically high price volatility has had a significant effect on the group's operating margin.
A high portion of this cost is typically hedged and covered by raw material clauses, but such clauses and hedges only protect for a limited period. Nonetheless, Michelin has an excellent track record of passing on raw material price increases to its customers. The group has again announced several price increases recently to reflect increases in commodity costs in the past year.
Financial Flexibility: Positive FCF has enabled Michelin to reduce debt steadily since the 2009 recession while funds from operations (FFO) have improved continuously. FFO adjusted net leverage declined to about 1x since 2013 from 3x at end-2009 in spite of significant capex and acquisitions. The acquisitions made in 2018 will lead to an increase of FFO adjusted net leverage to 1.8x at end-2018 according to our projections but we expect this ratio to decline back to around 1.5x in 2019 on improving FFO and robust FCF. Financial flexibility is also supported by the group's ability to lower or delay investment in case of sharper-than-forecast earnings weakening.
Strong Parent-Subsidiary Linkage: Legal, operational and strategic ties between Michelin and CFM are deemed strong enough by Fitch to align their ratings. CFM is a wholly-owned, strategic, subsidiary of Michelin and an integral part of the Michelin group. CFM owns most of the group's manufacturing, sales and research companies outside of France (representing about 90% of group net sales) and coordinates their operations. CFM also carries out legal, cash pooling and financing activities for the group.
Michelin's strong business profile is supported by the group's positioning in the tire industry, which is less volatile and cyclical than other segments of the auto supply industry and shares attributes of the consumer products sector. The group is a leading and recognised player in its sector and compares adequately with large and global suppliers, including Robert Bosch (F1), Continental AG (BBB+/Stable) and Aptiv PLC (BBB/Stable). Similar to the highest-rated automotive suppliers, Michelin has good geographical diversification, does not rely on any specific auto manufacturer and has advanced technology leadership in segments it covers.
With an EBIT margin of more than 12%, profitability is at the top end of the sector but Michelin's FCF margin is somewhat lower than that of most peers rated in the 'A' and 'BBB' categories, such as Caterpillar Inc. (A/Stable), Continental, BorgWarner Inc. (BBB+/Stable) and Aptiv. However, cash generation remains strong on an absolute basis and has been stable historically. Adjusted net leverage is expected to remain on average at 1.0x-1.5x over the foreseeable future, higher than Bosch's and Continental's but lower than BorgWarner's.
Fitch's Parent/Subsidiary Linkage methodology was used to derive the IDR of CFM. The ratings of Michelin and CFM are aligned due to the strong linkage between the two entities. No Country Ceiling or operating environment aspects affect the ratings.
Fitch's key assumptions within our rating case for the issuer include:
-Revenue to decline around 2% in 2018, mostly due to unfavourable foreign exchange developments and the deconsolidation of TCi. Revenue to then grow by high single-digits in 2019 and around 3% in 2020, due to underlying growth and the consolidation effect from acquisitions made in 2018.
-Cash outflows from the Camso, Fenner and Sumitomo JV transactions in 2018 but full revenue and earnings consolidation impact in 2019.
-Group operating margin to increase towards 13.5% through 2020, as margins of the passenger car division recover in 2019 and strengthen gradually to above 13%. Margins in trucks to recover slightly but remain below 10% and in specialty businesses to decline to 17.5%-18% because of the dilutive effect of the consolidation of Fenner and Camso. This includes a neutral net effect from pricing and raw material price developments and increasing gains from cost savings.
-Aggregate working capital outflows of around EUR450 million over 2018-2020 as lower receivables days and higher payable days partly offset higher inventory turnover days.
-Average capex intensity of just below 8% over 2018-2020.
-About EUR100 million of share buybacks per year and a pay-out ratio of about 40%.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
-FCF margin around 3% (2017: 2.2%, 2018E: 1.4%).
-FFO adjusted net leverage below 1x (2017: 0.9x, 2018E: 1.8x).
-Cash flows from operations (CFO)/lease-adjusted debt above 65% (2017: 69%, 2018E: 38%)
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
-FCF margin below 2%.
-FFO adjusted net leverage above 1.5x.
-EBIT margin below 10% (2017: 12.5%, 2018E: 12.4%).
Healthy Liquidity: Liquidity is supported by EUR1.4 billion of readily available cash at end-2017, after Fitch's adjustment for minimum operational cash of EUR0.5 billion and less than EUR0.1 billion of restricted cash as reported by the group. Michelin also had access to EUR1.5 billion committed and unutilised credit lines at end-2017. This largely covered EUR0.5 billion short-term debt at end-2017, which included EUR0.2 billion raised through its EUR1.5 billion euro commercial paper programme. Liquidity is further supported by our expectations of positive FCF generation.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Oct 10, 2018|
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