Fitch Affirms Snap-on Inc. at 'A'; Outlook Stable.
KEY RATING DRIVERS
Positive Consolidated Growth: The rating is supported by consistently positive consolidated growth within Snap-on's manufacturing operations and some variability across its three segments. Flat sales in the core Snap-on Tools Group year to date in 2017 follows seven years of mid- to high-single digit growth while the Repair Systems and Information (RS&I) Group continues to generate healthy top-line growth supplemented by acquisitions. These two groups together address the auto repair market and accounted for around 74% of Snap-on's sales in the latest 12 months (LTM) ended Sept. 30, 2017. The auto repair market is expected to continue to grow as vehicles age and become more technically complex.
Additional Growth Upside: The Commercial & Industrial (C&I) Group (26% of LTM sales) addresses industries outside the automotive repair segment including the aerospace, military, oil and gas, natural resources and power generation industries. This group generated healthy growth in the LTM period following several years of uneven growth due to challenging end-market conditions. Fitch expects that these three groups, collectively Snap-on's manufacturing operations, will maintain a low single-digit top-line growth rate over the medium term.
Improved Margins: Operating margins at Snap-on's manufacturing operations improved steadily from 2010 onwards reflecting the effect of sales volume leverage and savings from continuous improvement initiatives. Margins levelled off in the LTM period due to slower sales growth and the mix effect of recent acquisitions. However, Fitch believes there is additional upside to the manufacturing operating margin over the medium term due to continued volume growth and ongoing cost savings efforts.
Healthy Credit Business: Snap-on provides customer financing through Snap-on Credit (SOC), which had receivables of approximately $1.9 billion as of Sept. 30, 2017. This business provides strategic advantages to Snap-on in terms of attracting and retaining customers by structuring flexible payment terms. The company employs consistent underwriting standards and prudent risk management, and asset quality metrics are considered strong relative to the portfolio's subprime orientation, supported by weekly, in-person collections by the franchisees. At Sept. 30, 2017, 60-day delinquencies in the U.S. were 1.5% of total receivables.
Robust FCF: Fee cash flow (FCF) after dividends for the consolidated entity was $354 million in 2016, and is expected to continue in this range reflecting strong operating margins and relatively modest capital requirements (capex/revenues of 2% to 2.5%). Fitch expects FCF will be used to fund growth in the receivables portfolio at SOC as well as for acquisitions, funding pension liabilities, and share repurchases. Share repurchases accelerated to $213 million in the first nine months of 2017 from $76 million in the same period last year and these repurchases were debt-financed. Fitch expects share repurchases to moderate in 2018 and beyond to a level that can be financed with FCF.
Low Financial Leverage: All of Snap-on's long-term debt is at the parent level and is allocated internally to SOC. After this allocation, leverage at the manufacturing operations is immaterial and leverage at the financial services operations is low. Fitch expects manufacturing leverage will remain at low levels as its capital requirements are being funded with internally generated cash flow. On a consolidated basis, including the finance operations, leverage was 1.2x as of Sept. 30, 2017, in-line with recent levels. Fitch expects consolidated leverage will remain at or near 1x going forward absent a sizable acquisition.
Steady Financial Services Leverage: Under Fitch's criteria for rating non-financial corporates, a baseline debt/equity ratio for a captive finance company's operations is determined based on our assessment of the company's asset quality, liquidity and funding profile. In Snap-on's case, Fitch believes a leverage ratio of 5x or less is supportive of SOC's activities on a stand-alone basis. Leverage at SOC is currently well below 4x, and Fitch expects the company will maintain financial services leverage at current levels or modestly higher over the near to intermediate term, as receivables growth will likely be funded primarily with operating cash flow and debt levels will be relatively steady.
Credit Business Risk: Fitch views the credit business as moderately more risky than the manufacturing operations. As such, an extended period of growth of the receivables portfolio in excess of the growth of the manufacturing operations, causing the credit business to represent a materially larger proportion of consolidated assets and earnings, could be a rating concern.
Strengths and Concerns: Snap-on's ratings are supported by its strong operational performance, high level of customer brand loyalty, conservative financial management and consistent FCF generation. Key concerns include risks associated with the financial services business, such as the potential need for additional financial support from the parent company, the company's dependence on the auto repair market, and uneven results from the commercial and industrial (non-automotive) business.
Snap-on has a strong position relative to the peers in its core tools segment, where it is the clear industry leader in selling to automotive technicians. Snap-on also has a solid though less dominant position in its other segments. Snap-on's key competitors - Stanley Black & Decker and Fortive -- are both larger and more diversified, though Snap-on generates stronger margins and has lower financial leverage. A key distinguishing factor is Snap-on's financial services business, which enhances the competitiveness of its tools business but also raises the company's overall risk profile. No country-ceiling, parent/subsidiary or operating environment aspects impacts the rating.
Fitch's key assumptions within our rating case for the manufacturing operations, including the financial services business on an equity basis, include:
--Revenues grow at 6% in 2017, taking into account acquisitions, including Car-O-Liner. Sales grow at 4% annually thereafter assuming organic growth of 2%-3% and the balance from acquisitions.
--EBIT margins contract by around 30bps in 2017 due to pressure across all three segments, and recover gradually beginning in 2019.
--FCF approaches $300 million annually.
--Share repurchases step up in 2017 and moderate in 2018. Dividends grow faster than earnings over the forecast horizon.
--Debt levels at the manufacturing operations are assumed to be flat, and debt/EBITDA is steady at 0.2x, and adjusted debt/EBITDAR at 0.5x.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
-- An upgrade is not expected over the medium term. Longer term, factors that could lead to a positive rating action include continued healthy top-line growth at or above market growth rates, further improvement in consolidated EBITDA margins, improving asset quality metrics and financial leverage in the financial services business, and maintenance of minimal financial leverage at the manufacturing operations, even in the event of a larger acquisition.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
-- Factors that could lead to a negative rating action include deterioration in market fundamentals resulting in a sustained reduction in sales and cash flow or a large acquisition leading to an increase in leverage (debt/EBITDA and funds from operations [FFO] adjusted leverage) at the manufacturing operations to above 1.0x for an extended period.
-- A negative rating action would also be considered if the financial services operation experiences a substantial deterioration in asset quality and higher leverage levels that require meaningful support from the manufacturing operations.
Snap-on maintains solid liquidity including an undrawn $700 million revolver that is used in part to back commercial paper borrowings. Nearly all of the company's $94 million of total reported cash as of Sept. 30, 2017 is held at the manufacturing operation with a small amount held at the finance segment. $77 million of reported cash is currently held overseas with no near-term expectation of repatriation, leaving around $17 million as readily-available.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-Term IDR at 'A';
--Senior unsecured debt at 'A';
--Senior unsecured revolving credit facility at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
The Rating Outlook is Stable.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Jan 30, 2018|
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