Fitch Affirms American Axle's IDR at 'B+'; Outlook Positive
Fitch Ratings has affirmed the 'B+' Issuer Default Ratings (IDRs) of American Axle & Manufacturing Holdings, Inc. (AXL) and its American Axle & Manufacturing, Inc. (AAM) subsidiary. Fitch also has affirmed the ratings on AAM's secured revolving credit facility and 9.25% senior secured notes at 'BB+/RR1'. Fitch has upgraded AAM's senior unsecured notes rating to 'B/RR5' from 'B-/RR6'. A full list of the rating actions taken on AXL and AAM is included at the end of this release. AAM's ratings apply to a $365 million secured revolving credit facility, $340 million in senior secured notes and $1.2 billion of senior unsecured notes. The Rating Outlook for both AXL and AAM is Positive.
KEY RATING DRIVERS
The ratings and Positive Outlook for AXL and AAM are supported by Fitch's expectation that the drivetrain and driveline supplier's credit profile will strengthen over the intermediate term, despite some deterioration over the past year. AXL continues to benefit from strong pickup and sport-utility vehicle (SUV) production at its two largest customers, General Motors Company (GM) and Chrysler Group LLC (Chrysler), and the company's margins are rising back toward their historically strong levels among the strongest in the U.S. auto supply industry. Weakness in AXL's profitability and credit profile over the past year was largely due to factors that Fitch views as temporary, including production inefficiencies tied to two new product programs, as well as incremental costs tied to the closure of the company's Detroit Manufacturing Complex (DMC) and Cheektowaga Manufacturing Facility (CKMF).
Looking ahead, Fitch views the increasing diversification of AXL's book of business as a credit positive that will reduce the company's outsized reliance on U.S. light truck production. Passenger car, crossover, and commercial vehicle related programs comprise a growing portion of the company's revenue base, while an expanding list of customers is reducing AXL's traditional reliance on GM for the majority of its business. The latter includes an increasing number of non-U.S. manufacturers, as well, which will further geographically diversify the company's revenue base. AXL's backlog of new business currently stands at $1.25 billion, 60% of which is for passenger car and crossover programs and 40% is for programs outside North America. By mid-decade, AXL expects about half of its revenue base to come from non-GM programs. It is notable, however, that the company's current exposure to the weak European market remains small, with only 3% of its 2012 revenue generated in the region.
The upgrade of AAM's senior unsecured notes recovery rating to 'RR5' from 'RR6' reflects Fitch's revised recovery expectations for the notes in a distressed scenario. Growth in AXL's overall business has led Fitch to increase its assumed enterprise value for the company in a post-distressed scenario. This, combined with a significant improvement in the funded status of the company's pension plans, has increased the estimated recovery of the senior unsecured notes to the 10% to 30% range in a distressed scenario from Fitch's earlier estimate of 0% to 10%. The recovery ratings of 'RR1' on AAM's secured revolving credit facility and its senior secured notes continues to be based on their strong collateral coverage, including virtually all of the assets of AXL and AAM, leading to recovery prospects of 90% or higher in a distressed scenario.
Despite its increasing revenue diversification, AXL's ratings will continue to be weighed upon in the near term by its ongoing heavy exposure to GM's light truck platform, although the significant progress AXL has made in reducing its cost base places it in a better position today to withstand any future downturn in light truck demand. Also, with the recent redesign of GM's full-size pickups and the forthcoming redesign of its SUVs, Fitch expects near-term demand for GM's full-size trucks and SUVs to remain high, which will benefit AXL's near-term profitability. AXL's ratings are also weighed upon by risks associated with the large number of new programs currently ramping up. Although Fitch views the increasing diversification as a credit positive overall, there are risks associated with the start-up of new programs, as was seen in 2012. Free cash flow in the near term is likely to be pressured somewhat by increased capital spending and temporary production inefficiencies tied to new program starts, even if the programs ramp up smoothly.
Free cash flow (calculated as net cash from operations less gross capital expenditures) in the 12 months ended June 30, 2012, was a use of $403 million, pressured by a number of non-recurring items. These included increased cash costs related to the aforementioned starts, including unexpected costs tied to the production issues that have since been largely rectified. Free cash flow also was negatively affected by higher-than-normal capital spending related to new product programs, as well as cash costs related to the closure of DMC and CKMF and the reallocation of production from those plants to other facilities. Also included in Fitch's calculation of free cash flow is $225 million of pension contributions made in the latter half of 2012, which included $115 million related to an agreement with the Pension Benefit Guaranty Corporation (PBGC) following the DMC and CKMF plant closures. The PBGC-related contribution was funded with a portion of the proceeds from a $550 million debt issuance during the third quarter of 2012.
Going forward, Fitch expects free cash flow to improve as new product programs get underway and capital spending trends down toward more typical levels once the company progresses past the heaviest part of its new business roll-out. Also, following the significant pension contributions in 2012, AXL is not expected to have any meaningful required pension contributions for the next several years, which will further bolster free cash flow. For 2013, above-normal capital spending is likely to keep free cash flow for the year modestly negative, but Fitch expects it to grow and turn positive in 2014 on higher production, improved margins and lower capital spending.
Despite the negative free cash flow in the 12 months ended June 30, 2013, overall liquidity remains adequate. Cash and cash equivalents at June 30, 2013, totaled $79 million, and the company had $342 million available on its $365 million secured revolver. AXL had no meaningful near-term debt maturities at June 30, 2013, although AXL has the opportunity to pre-pay $42.5 million of its 9.25% senior secured notes in the fourth quarter of 2013, and it can call the remaining senior secured notes for redemption in January 2014. Overall, Fitch expects cash and revolver availability to remain more than sufficient over the intermediate term, although the company could access the capital markets within the next few months to fund the redemption of the secured notes.
AXL's leverage (debt/Fitch-calculated EBITDA) increased during the 12 months ended June 30, 2013, to 4.8x from 3.4x in the year-earlier period on an increase in debt and a decline in EBITDA. Overall, debt rose to $1.5 billion from $1.2 billion while Fitch-calculated EBITDA declined to $322 million from $347 million. Fitch expects leverage to improve meaningfully over the intermediate term as the company looks for opportunities to reduce debt and as EBITDA grows on higher business levels and stronger margins. Fitch expects leverage to trend down toward the mid-3x range by year-end 2013 and potentially below 3x by the end of 2014.
Fitch does not view AXL's defined benefit pension plans as a significant credit risk. At year-end 2012, the plans were 83% funded on a projected benefit obligation (PBO) basis, equating to a $147 million net liability. The substantial contributions that the company made to the plans in 2012 more than offset the effect of lower interest rates on the PBO calculation. AXL's PBO calculation was based on a 4% discount rate, and Fitch expects that if the rise in long-term interest rates seen thus far in 2013 holds through year end, it will have a meaningful positive effect on the plans' underfunded status at year end 2013. As noted earlier, following substantial pension contributions in 2012, Fitch does not expect AXL to have any required pension contributions in the U.S. over the intermediate term.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Continued progress on diversifying the company's revenue base.
--Sustained positive free cash flow generation.
--A decline in leverage to the mid-3x range.
--Sustained EBITDA margins of 12% or higher.
Negative: The current Rating Outlook is Positive. As a result, Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating downgrade. However, the following developments could lead Fitch to revise the Rating Outlook to Stable or Negative or downgrade the ratings.
--Significant production inefficiencies and associated cash burn tied to the start-up of new programs.
--A lack of progress on meaningful leverage reduction.
--A shift in management's plans to strengthen the company's credit profile.
--An unexpected prolonged disruption in the production of GM's full-size pickups and SUVs.
Fitch has taken the following rating actions with a Positive Outlook:
--Issuer Default Rating (IDR) affirmed at 'B+'.
--IDR affirmed at 'B+';
--Secured credit facility rating affirmed at 'BB+/RR1';
--Senior secured notes rating affirmed at 'BB+/RR1';
--Senior unsecured notes rating upgraded to 'B/RR5' from 'B-/RR6'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
-- Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage (Aug. 5, 2013);
-- Evaluating Corporate Governance (Dec. 12, 2012);
-- Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (Nov. 13, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Evaluating Corporate Governance
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
Craig D. Fraser
Mark A. Oline
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