Fitch Upgrades Sanmina’s IDR to ‘BB+’; Outlook Stable
By Business Wire News
Fitch Ratings has upgraded the long-term Issuer Default Rating (IDR) for Sanmina Corporation (Sanmina) to ‘BB+’ from ‘BB’. In addition, Fitch has affirmed the senior secured revolving credit facility (RCF) rating at ‘BBB-‘ and assigned a recovery rating of ‘RR1’; and affirmed the senior secured notes at ‘BB+’ and assigned a recovery rating of ‘RR3’.
Fitch’s actions affect $500 million of total debt. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings and Outlook reflect Fitch’s expectations for improving operating performance through the intermediate term, driven by positive organic revenue growth from increasing exposure to faster growing emerging end markets, including industrial, defense and medical. Fitch expects profit margins to expand with a higher mix of emerging end market sales and higher annual free cash flow (FCF) from longer life cycles associated with these products.
Strength in Sanmina’s industrial, defense, and medical end markets (roughly 40% of total sales) should continue, driven mainly by design wins amidst increasing electronics content. Fitch expects communications and networks end markets (35%-40% of sales) are stabilizing and poised to resume modest growth, although demand will remain uneven given uneven wireless carrier spending. Embedded computing and storage markets will remain flat.
Increased penetration of emerging industrial, defense and medical end markets and investments in Components, Products and Service segment (CPS) should drive positive low single digit mid-cycle revenue growth over the longer term. In addition, Fitch expects the increased mix of faster growing and higher gross margin CPS sales will drive mid-cycle profitability higher, although operating EBITDA margins will remain in the mid-single digits, consistent with the operating profile of the electronics manufacturing services (EMS) industry.
Fitch estimates operating EBITDA margin was 5.3% for the latest 12 months (LTM) ended June 27, 2015, versus 5.1% for the prior year, driven in part by gross profit margin expansion in the Integrated Manufacturing Solutions (IMS) segment. As a result, Fitch expects annual FCF of more than $200 million, versus Fitch’s prior expectations of $100 million to $200 million. Nonetheless, quarterly FCF will remain uneven, given higher inventory levels attendant with larger-scale new program ramps.
Fitch expects Sanmina will use FCF for share repurchases and small technology focused acquisitions, targeting new capabilities and customer relationships. Acquisition activity has been minimal over the past few years. Nonetheless, Fitch expects Sanmina will exhaust the current $200 million share repurchase authorization, as $55.7 million was available for repurchase under the programs as of June 27, 2015.
Fitch does not anticipate Sanmina will use FCF for further debt reduction, following roughly $475 million of debt repayments in recent years. Fitch continues to expect Sanmina to maintain strong credit protection measures for the rating, including total leverage (total debt to operating EBITDA) below 2 times (x) and FCF to total debt of more than 20%. For the LTM ended June 27, 2015, Fitch estimates total leverage was 1.3x and FCF to total debt was 40%, strengthened from 1.7x and 31% in the comparable prior year period.
The ratings are supported by:
–Favorable industry trends toward increased outsourcing in underpenetrated markets for product design consultation, component sourcing, manufacturing, fulfilment, logistic and repair/reverse logistics.
–Significant capabilities in low volume, high mix design and assembly, positioning Sanmina to gain share in non-traditional end markets.
–Consistent annual FCF from profitability expansion during positive demand environments and cash generation from lower inventory levels in a downturn.
Ratings concerns center on:
–Low mid-cycle profit margins associated with the EMS model, resulting in minimal room for execution missteps.
–Ongoing volatility associated with roughly 35%-40% of revenues in more projected oriented legacy networking and communications end markets, although this is down from 40%-45% just a year ago.
–Customer concentration with Sanmina’s top 10 customers representing roughly half of revenues, in-line with the EMS industry.
Fitch’s key assumptions within our rating case for the issuer include:
–Low-single digit revenue growth for the fiscal year ending Sept. 30, 2015 and over the longer term, driven by increased penetration of emerging markets.
–Operating EBITDA margin in the 5%-5.5% range, driven by an increasing mix of higher margin emerging markets sales.
–Consistent inventory turns and capital spending, resulting in annual FCF of more than $250 million.
–Limited incremental debt reduction through the forecast period and FCF used primarily for share repurchases, given sufficient cash levels.
Positive rating actions could occur if:
–Fitch expects higher focus revenue growth will translate into annual FCF of $250 million to $500 million; and
–Mid-cycle operating EBITDA structurally above 5% in conjunction with a commitment to maintain total leverage below 2x.
Negative rating action could occur if:
–Fitch expects annual FCF sustained below $200 million from weaker than anticipated revenue growth or profitability; or
–Profitability pressures resulting in operating EBITDA approaching 4% or debt financed acquisitions of manufacturing assets resulting in total leverage sustained above 3x.
Sanmina’s liquidity was solid as of June 27, 2015, and supported by:
–$417 million in cash and short-term investments, of which 43% ($179 million) is held within the U.S.; and
–$348 million of availability (net of $22.4 million in LOCs and $5 million drawn) under the $375 million senior secured RCF due May 2020.
Fitch’s expectation for annual FCF of more than $200 million through the rating horizon also supports liquidity.
Total debt was $432.2 million as of June 27, 2015 and consisted of:
–$5 million drawn under the company’s RCF;
–$40 million loan secured by the company’s corporate campus;
–$12.2 million of non-interest bearing notes; and
–$375 million of senior secured 4.375% notes due June 2019.
FULL LIST OF RATING ACTIONS
Fitch has taken the following rating actions:
–Long-term IDR upgraded to ‘BB+’ from ‘BB’;
–Senior secured RCF affirmed at ‘BBB-‘ and assigned an ‘RR1’ recovery rating;
–Senior secured notes affirmed at ‘BB+’ and assigned an ‘RR3’ recovery rating.
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
Alyssa Castelli, New York, +1-212-908-0540
Jason Pompeii, +1-312-368-3210
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
David Peterson, +1-312-368-3177
Eric Rosenthal, +1-212-908-0286