Fitch Affirms Cummins at ‘A’; Outlook Stable
By Business Wire News
By Business Wire News
Fitch Ratings has affirmed Cummins, Inc.’s (CMI) Issuer Default Rating (IDR) and long-term debt ratings at ‘A’. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings incorporate CMI’s strong operating profile including competitive positions in its engine and power generation markets, strong technological capabilities, and global distribution network. CMI’s low leverage and consistently positive free cash flow (FCF) through downturns mitigate risks related to the company’s exposure to cyclical heavy- and medium-duty truck, off-road equipment, and power generation markets. At June 28, 2015 debt/EBITDA was 0.6x and FCF/total adjusted debt was 22%. CMI’s leverage would be lower when considering the impact of earnings from manufacturing and distributor joint ventures which are excluded from Fitch’s calculation of EBITDA.
Rating concerns include possible changes to CMI’s financial policies, which typically have been targeted toward a strong balance sheet and a high level of financial flexibility consistent with the company’s ‘A’ ratings. The company stated during its second quarter earnings call that, while its financial policies have not changed, it is focused on generating higher growth and returns to shareholders and could be comfortable with leverage that is higher than the company’s previously low levels. In Fitch’s view, there is room at CMI’s current ratings for a modest increase in leverage, including an increase in debt/EBITDA to slightly above 1x, but Fitch could consider a negative rating action if credit metrics appear likely to weaken significantly.
Fitch estimates CMI’s results in 2015 will improve slightly, including revenue growth in the low single digits as the addition of recently acquired distributors and strong demand for heavy and medium duty trucks in North America offsets the negative impact of currency and weaker demand in international markets. Margins could increase for all of 2015 due to the consolidation of higher-margin distribution revenue and lower cost of materials. Low margins in the Power Generation business are recovering as it completes restructuring actions.
Fitch estimates free cash flow (FCF) after dividends for all of 2015 will be at least $600-$700 million compared to $873 million in 2014. The decline reflects higher dividend payments and a slight increase in working capital assumed by Fitch. Dividends have increased materially in the past two to three years as part of CMI’s plan to return 50% of operating cash flow to shareholders.
CMI’s cash deployment includes returning 50% of operating cash flow to shareholders. The company repurchased $514 million of shares during the first half of 2015; more than $500 million of capacity remains under the existing repurchase program. CMI also expects to spend $150 million – $190 million in the third quarter of 2015 for distributor acquisitions.
Other rating concerns include CMI’s exposure to the cyclical heavy duty truck market in North America and the risk of vertical integration by CMI’s truck engine customers, many of whom manufacture engines as well as trucks. CMI’s share of engine sales in the North America heavy duty market has declined to a range near 35% compared to the high-30% range previously as certain customers supply a larger proportion of their own engines and as vertically integrated Europe-based truck makers increase their presence in the U.S. CMI’s share of the medium duty truck market in North America is materially higher than heavy duty engines but is subject to similar concerns.
The impact from the loss of market share is partly offset by CMI’s expansion in emerging regions, particularly through joint ventures and new product introductions in China that have benefited from trends toward stricter emissions standards, demand for better fuel efficiency and more technology content. New product introductions by CMI’s joint ventures and components business in China are boosting revenue despite slowing economic growth in the region and lower industry demand. Slower growth in emerging markets, including Brazil, is a continuing concern.
Production of heavy duty trucks in North America may be near a cyclical peak which could limit CMI’s revenue growth when industry demand tapers off. However, the pace of a downturn in industry truck production, when it occurs, could be relatively moderate, reflecting the measured pace of increases in production compared to previous cycles. Also, freight volumes remain solid and replacement demand is supported by the age of the industry fleet which remains elevated.
The majority of CMI’s recent acquisition spending has been used to purchase the remaining equity in most of its U.S. and Canadian distributors. These acquisitions are expected to be largely completed by the end of 2015. Full ownership of the distributors should enable CMI to streamline operations and improve customer support. It also provides an opportunity to capture distribution aftermarket revenue from parts, filtration and service which tend to be more stable than CMI’s original equipment business.
Joint venture income from unconsolidated ventures, primarily related to the engine and distribution segments, generates approximately 13% of segment profit. The proportion of CMI’s earnings from joint ventures has declined slightly due to the company’s acquisitions of its partly-owned distributors in the U.S. and Canada since 2013, partly offset by an increase in income from the Beijing Foton engine joint venture. China should be a source of long-term demand, but there are concerns about government constraints on participation by foreign companies and the near-term impact of recent large declines in industry truck production.
Fitch’s key assumptions within the rating case for the issuer include:
–North America truck production reaches a cyclical peak in 2015 and begins to decline in 2016;
–CMI’s engine market share in North America declines gradually due to vertical integration by heavy duty truck OEMs;
–CMI gains additional market share in China, including consolidated and joint venture revenue;
–CMI pays approximately 50% of operating cash flow as dividends and share repurchases;
–FCF of $600-$700 million in 2015;
–Segment EBIT margins increase by approximately 50-100 bps in 2015.
Future developments that may, individually or collectively, lead to a negative rating action include:
–Market share in the North America heavy duty Class 8 truck market deteriorates as a result of customer in-sourcing or competitive pressure, without offsetting gains in other markets;
–CMI loses competitiveness as a result of ineffective new product development;
–Cash deployment for share repurchases or other discretionary spending contributes to consistently higher leverage, including debt/EBITDA consistently above 1.25x;
–Weak FCF resulting in FCF/Total Adjusted Debt declining to the mid-teens compared to levels above 20% historically.
Fitch believes a positive rating action is unlikely given cyclicality in CMI’s end markets and the possibility of a change in the company’s financial policies. However, future developments that may, individually or collectively, lead to a positive rating action include:
–Consistently higher margins through business cycles, including EBITDA margins near 15% or higher compared to a range of 12%-14% since 2010;
–FCF/Total Adjusted Debt consistently above 25%;
–Vertical integration by heavy duty truck manufacturers is limited, allowing CMI to maintain or increase market share;
–Debt/EBITDA is reduced consistently below 0.5x and FFO adjusted leverage declines below 1.0x.
Liquidity at June 28, 2015 included cash and marketable securities of approximately $1.8 billion. Approximately $1 billion of CMI’s cash was held outside the U.S., much of which would incur taxes if repatriated. Liquidity also included availability under a $1.75 billion five-year revolver which matures in 2018, most of which was available. Liquidity was offset by $31 million of current maturities of long-term debt and $70 million of loans payable. Debt maturities are spread out, with no significant maturities scheduled before 2023. CMI’s debt totaled nearly $1.7 billion at June 28, 2015.
CMI expects to contribute $175 million to pension plans in 2015, including $93 million of required contributions, compared to $205 million of total contributions in 2014. The plans in both the U.S. and U.K. are overfunded which minimizes the likelihood of large future contributions and supports FCF.
FULL LIST OF RATING ACTIONS
Fitch has affirmed CMI’s ratings as follows:
–IDR at ‘A’;
–Senior unsecured credit facility at ‘A’;
–Senior unsecured debt at ‘A’.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form
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