Fitch Downgrades Navistar's IDR to 'B-'; Rating Outlook Negative.
CHICAGO -- Fitch Ratings has downgraded the Issuer Default Ratings (IDR) for Navistar International Corporation (NAV) and Navistar Financial Corporation (NFC) to 'B-' from 'B+'. NAV's senior unsecured debt is downgraded to 'CCC' from 'BB-', and NFC's senior secured bank credit facilities are downgraded to 'CCC' from 'BB-'. Fitch has assigned an expected rating of 'BB-' to Navistar, Inc.'s planned senior secured term loan facility of up to $1 billion announced Aug. 2, 2012. NAV will guarantee the facility. NAV's senior subordinated convertible debt is downgraded to 'CC' from 'B-'. The rating Outlook is Negative. A full list of ratings follows at the end of this release.
The rating downgrades for NAV and NFC consider the negative impact of recent developments including already weak operating results in 2012 that are likely to be worse than previously expected by Fitch. Results will continue to be pressured by costs to incorporate Cummins emissions technology and engines in NAV products and slower growth in demand for trucks in North America and other regions related to economic concerns. In addition, NAV's market share in the near term is subject to its reliance on non-conformance penalties (NCP) and emissions credits to sell trucks during the transition to NAV's revised engine strategy, even while discussions continue with the Environmental Protection Agency (EPA) and California Air Resources Board (CARB). NFC's performance has not changed materially compared to Fitch's expectations, but its financial profile is likely to be affected over the long term by lower than expected volumes at NAV and NFC's strong linkage to its manufacturing parent.
NAV is in the process of obtaining a senior secured term loan of up to $1 billion. The facility would strengthen the company's liquidity and mitigate concerns in the near term about weak free cash flow and costs to implement NAV's revised engine strategy. A portion of the term loan proceeds will be used to repay outstanding balances under NAV's asset-based credit facility ('ABCL'), with the remainder available to fund working capital and general corporate purposes.
The Negative rating Outlook reflects execution risks associated with the transition in NAV's engine strategy that has contributed to NAV's reduced market share; a large net pension obligation; engine quality issues that contributed to high warranty charges in the first half of fiscal 2012; and high leverage. Manufacturing debt/EBITDA increased materially in the first half of 2012, to slightly above 4 times (x) at April 30, 2012, and can be expected to increase materially as a result of NAV's new term loan and near term earnings pressure. In addition, NAV disclosed that it received a subpoena from the SEC with respect to a formal order of investigation for the period November 1, 2010 to the present concerning accounting and disclosure issues.
NAV's revised engine strategy involves some uncertainty about its ability to deliver trucks until it has redesigned its trucks and engines. Emissions credits are expected to be depleted in 2012 for heavy duty engines and in 2013 for medium duty engines. NAV is discussing its engine plans with the EPA and the California Air Resources Board (CARB), but the outcome has yet to be determined and may be subject to legal review. In June 2012, the U.S. Court of Appeals invalidated the EPA's Interim Final Rule allowing NAV to use NCP's, although the ruling has not yet been put into effect.
NAV's ratings could be reviewed for a possible downgrade if warranty costs don't stabilize and eventually improve, free cash flow doesn't recover when NAV completes the transition of its engine strategy, or the company's engineering integration strategy and expansion overseas fail to produce improved margins. If sales volumes and margins are pressured, FCF could be impaired, making it difficult to fund capital expenditures, pension contributions and higher interest expense. Liquidity provided by the proposed term loan provides time to execute NAV's engine strategy, but it could potentially be reduced the concerns just mentioned about volumes, margins and FCF. In addition, three investors have accumulated approximately 48% of NAV's common shares in recent months which introduces some uncertainty about long term operating and financial policies.
The rating Outlook could eventually be changed to Stable if NAV is able to maintain production levels through the use of emissions credits and NCP's. The ratings and outlook could also be supported if engine quality improves materially, operating margins improve, leverage declines, and the company's market share recovers.
NAV's proposed term loan reduces recovery prospects for NAV's unsecured debt. The recovery rating of '1' for the term loan supports a rating of 'BB-', three levels above NAV's IDR, as the loan can be expected to recover more than 90% in a distressed scenario based on a strong collateral position. The '5' recovery rating for NAV's senior unsecured debt results in a rating of 'CCC', one notch below the IDR, and reflects poor recovery prospects in a distressed scenario. A recovery rating of '6' for the senior subordinated convertible notes reflects a lower priority relative to NAV's senior unsecured debt. Consistent with the unsecured facility ratings of NAV, NFC's secured bank facility is rated one notch below its IDR of 'B-' due to a collateral position that ranks behind a material amount of higher-priority encumbered debt of the finance company.
A material loss in the first half of 2012 reflected large warranty charges, higher commodity costs for steel and rubber, the negative impact of lower sales of military trucks and parts, weak demand in Brazil associated with engine pre-buying in 2011, and a transition to contract engine manufacturing for a large customer in Brazil. NAV also incurred start-up and restructuring costs in certain businesses and relocated its headquarters as part of the engineering integration. The company doesn't expect to return to profitability until the fourth quarter.
Fitch expects costs related to the change in NAV's engine strategy could result in negative manufacturing free cash flow (FCF) in the second half of fiscal 2012 and potentially into fiscal 2013 until the engine transition is complete. Manufacturing FCF in the first half of 2012 was negative $388 million, reflecting low margins and capital expenditures which remain higher than average as NAV integrates its engineering functions, invests in a research center and engine testing facility, and realigns other parts of its business.
NAV's manufacturing FCF is also constrained by recurring pension contributions. NAV's net pension obligations totaled $1.8 billion (approximately 57% funded) at the end of 2011. As of April 30, 2012, NAV expected to contribute $190 million to the plans in 2012, of which $82 million was contributed during the first half of the year. Between 2013 and 2015, NAV estimated it would be required to contribute at least $210 million annually. However, the company has indicated that required contributions could be less than these estimates based on recent pension legislation.
At July 31, 2012, Navistar estimated manufacturing cash and marketable securities at $575 million - $625 million, compared to nearly $1.2 billion at Oct. 31, 2011. Liquidity also included a $355 million 'ABCL' that matures in 2016. Liquidity will increase upon completion of NAV's new senior secured term loan. As of April 30, 2012, there was $230 million of manufacturing debt due within one year, including $100 million due under the ABCL. NAV borrowed an additional $138 million under the facility in June 2012. Beyond one year, NAV's $570 million of senior subordinated convertible note are scheduled to mature in October 2014.
Fitch views NFC as neutral to the rating. NFC's financial performance is generally in line with Fitch's expectations. Profitability declined slightly in the six-months ended April 30, 2012 due to the run-off of NFC's retail portfolio, and future profitability at NFC will be directly affected by the general operating performance and financial condition of NAV. Furthermore, the retail balance is expected to decline over the next several years due to NFC's agreement with GE Capital in 2010 as the primary funding source for the company's retail portfolio.
Asset quality continues to improve and provisioning volatility has declined as NFC focuses on its relatively lower risk wholesale portfolio. Absent material dividends upstreamed to the parent, Fitch expects NFC's leverage to improve and stay below historical levels due to reduced financing needs as a result of NFC's agreement with GE Capital. In the fourth quarter of calendar 2011, NFC completed a significant refinancing of its credit facilities. Fitch believes the refinancing of its credit facilities may mitigate any potential near-term liquidity concerns.
The ratings of the finance subsidiary are directly linked to those of its ultimate parent due to the close operating relationship and its strategic importance to NAV. This linkage outweighs the stand-alone credit profile and operating performance of NFC, as substantially all of NFC's business is connected to the financing of new and used trucks sold by NAV and its dealers. The relationship between NAV and NFC is formally governed by the Master Intercompany Agreement. Also, there is a requirement referenced in NFC's credit agreement requiring Navistar, Inc. or NAV to own 100% of NFC's equity at all times.
Fitch's ratings cover approximately $2 billion of debt at NAV and $2.5 billion of outstanding debt at its Financial Services segment, the majority of which is at NFC, as of April 30, 2012.
Fitch has taken the following rating actions:
Navistar International Corporation --Long-term IDR downgraded to 'B-' from 'B+'; --Senior unsecured notes downgraded to 'CCC'/'RR5' from 'BB-'/ 'RR3'; --Senior subordinated notes downgraded to 'CC'/'RR6' from 'B-'/'RR6'.
Navistar, Inc. --Long-term IDR rated 'B-'; --Senior secured bank term loan facility assigned an expected rating of 'BB-'/'RR1';
Cook County, Illinois --Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 downgraded to 'CCC' from 'BB-'.
Illinois Finance Authority (IFA) --Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 downgraded to 'CCC' from 'BB-'.
Navistar Financial Corporation --Long-term IDR downgraded to 'B-' from 'B+'; --Senior secured bank credit facilities downgraded to 'CCC'/'RR5' from 'BB-'/ 'RR3'.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 12, 2011); --'Finance and Leasing Companies Criteria' (Dec.12, 2011); --'Rating Linkages in Nonbank Financial Subsidiary Relationships' (Nov. 29, 2011); --'Global Financial Institutions Rating Criteria' (Aug. 16, 2011).
Applicable Criteria and Related Research: Corporate Rating Methodology http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229 Finance and Leasing Companies Criteria http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=659834 Rating Linkages in Nonbank Financial Subsidiary Relationships http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=656583 Global Financial Institutions Rating Criteria http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=649171