Fitch Upgrades Goodyear's IDR to 'BB-'; Outlook Stable
GT's ratings apply to a \$2 billion secured revolving credit facility, a \$1.2 billion second lien secured term loan and \$3 billion in senior unsecured notes. GDTE's ratings apply to a EUR400 million secured revolving credit facility and EUR250 million of senior unsecured notes.
The Rating Outlooks for GT and GDTE are Stable.
KEY RATING DRIVERS
The upgrade of GT's IDR reflects the improvement in the tire manufacturer's credit profile resulting from its significantly improved profitability, especially in North America, and the substantial decline in its pension obligations after fully funding its North American plans. GT's focus on more profitable high value added (HVA) tires and its cost reduction initiatives have resulted in substantial margin growth and increased operating income, even as its global tire volumes and consolidated revenue have declined. Despite lower sales, GT has retained a strong market position and remains the third-largest global manufacturer of replacement and original equipment (OE) tires. With its higher profitability, free cash flow (FCF) continued to strengthen in 2014, although discretionary pension contributions made early in the year kept the full-year FCF figure negative.
Fitch expects GT's credit protection metrics will strengthen over the intermediate term as overall tire demand grows along with the global car parc, particularly in emerging markets, and the company continues to work on improving its cost structure. Fitch expects leverage to decline over the intermediate term, as GT's earnings rise and as it focuses on reducing debt. Fitch also expects the variability of the company's quarterly cash flows to decline as it continues to focus on working capital management. It is also notable that the company released its U.S. tax valuation allowance in the fourth quarter of 2014, recording a \$2.3 billion gain in the process. The U.S. valuation allowance was first established over 12 years ago, and Fitch views the release as a positive sign that the company is on track to produce sustainable profits in the U.S.
Fitch's rating concerns continue to include growing tire industry capacity, particularly in North America, which could pressure industry pricing over the longer term, and volatility in raw material costs, especially for natural rubber and petroleum-based commodities. Conditions in the European tire market also remain a concern, despite some improvement over the past two years. Fitch's other concerns include fixed costs in GT's business and the related sensitivity of its financial performance to economic conditions; the aforementioned working capital variability, despite expectations for improvement; and overall profitability that continues to lag several of GT's key European and Asian competitors. The increase in GT's shareholder-friendly activities over the past two years, including a rising dividend and share repurchases, is a concern, although Fitch does not expect the company to incur additional long-term debt to fund these activities.
Fitch notes that the majority of GT's debt has been issued in the U.S. including \$3 billion in senior unsecured notes. However, in 2014, 55% of the company's revenue was generated outside North America, and at year-end 2014, about 65% of the company's consolidated cash, or \$1.4 billion, was at non-guarantor subsidiaries outside the U.S. Of the \$1.4 billion, \$494 million was located in the company's subsidiaries in China, Venezuela, South Africa and Argentina, where there are limitations on cash transfers out of the respective countries. This mismatch between cash and debt is a risk, because if GT's U.S. operations were to fall into distress, the non-U.S. cash might not be readily available to service the company's U.S. debt obligations. For this reason if, in the future, GT's IDR were downgraded, the magnitude of a concurrent downgrade in GT's senior unsecured rating might exceed that of the IDR.
The rating of 'BB+/RR1' on GT's and GDTE's secured credit facilities, including GT's second-lien term loan, reflects their substantial collateral coverage and outstanding recovery prospects in a distressed scenario. The two-notch uplift from the IDRs of GT and GDTE reflects Fitch's notching criteria for issuers with IDRs in the 'BB' range. On the other hand, the rating of 'BB-/RR4' on GT's senior unsecured notes reflects Fitch's expectation that recoveries would be average in a distressed scenario, consistent with most senior unsecured obligations of issuers with an IDR in the 'BB' range. The two notch upgrade of the senior unsecured notes also reflects their improved recovery prospects following the substantial decline in, and subsequent de-risking of, GT's U.S. unfunded pension obligations.
The rating of 'BB/RR2' on GDTE's EUR250 million 6.75% senior unsecured notes due 2019 is higher than the rating on GT's senior unsecured notes due to the GDTE notes' structural seniority. GDTE's notes are guaranteed on a senior unsecured basis by GT and GT's subsidiaries that also guarantee the parent company's secured revolver and second-lien term loan. Although GT's senior unsecured notes also include guarantees from the same subsidiaries, they are not guaranteed by GDTE. The recovery prospects of GDTE's notes are further strengthened relative to those at GT by the lower level of secured debt at GDTE. Fitch notes that GDTE's credit facility and its senior unsecured notes are subject to cross-default provisions relating to GT's material indebtedness.
In 2014, GT commenced arbitration proceedings against Sumitomo Rubber Industries, Ltd. (SRI), GT's partner in a wide-ranging global alliance that includes most of GT's operations in Western Europe, as well as other businesses in North America and Asia. GT is currently seeking to dissolve the alliance, based on its claims that SRI has engaged in anticompetitive actions. Few details have been made public thus far, but GT has noted that it could ultimately be required to purchase SRI's stake in GDTE and Goodyear Dunlop Tires North America (GDTNA), potentially using proceeds from any damages awarded to GT in the arbitration proceedings. Nonetheless, GT could ultimately incur some cash costs to acquire SRI's stake in the alliance. A substantial cash payment could be a rating concern, but these types of proceedings often take a long time to resolve, so the outcome may not be known for several years.
GT's FCF generation has improved markedly over the past several years. Although FCF in 2014 was (\$707) million, this included a \$907 million discretionary contribution the company made to its U.S. hourly pension plan in the first quarter of 2014. Absent this contribution, FCF would have been \$200 million. In 2013, FCF would have been positive absent discretionary pension contribution that year as well, following several years of negative FCF. The improvement in GT's FCF generating capability has largely been driven by its HVA tire focus, increased traction on cost reduction activities and lower raw material prices. With its U.S. pension plans almost fully funded, Fitch expects GT to generate positive FCF over the intermediate term, although volatility in raw material prices remains an ongoing risk. Putting some pressure on FCF in 2015 is an expected increase in capital spending of roughly \$200 million to a total of \$1.1 billion, as well as the effect of a 20% increase in the company's dividend that was enacted in mid-2014. However, the dividend increase was offset by the mandatory conversion of the company's preferred stock in April 2014 that removed \$29 million in annual preferred stock dividends.
The funded status of GT's pension plans has improved significantly following the company's discretionary contributions to its U.S. salaried and hourly plans in 2013 and 2014, respectively. The discretionary contributions served to fully fund the plans, after which, the company de-risked the plans by shifting the balance of plan assets to nearly all fixed-income investments. Based on its labor agreement with the United Steelworkers (USW), GT also froze its U.S. hourly plan in April 2014. As a result of these actions, Fitch no longer views the funded status of GT's pension plans as a material rating concern. The U.S. plans were 96% funded at year-end 2014 despite a decline in interest rates and the use of revised mortality tables that increased the liability. GT's global plans were 93% funded. GT has estimated that its 2015 pension contributions will be between \$50 million and \$75 million, which will contribute to significantly improve near-term FCF.
GT's liquidity position remains relatively strong. At year-end 2014, GT had \$2.2 billion in cash and cash equivalents and another \$1.6 billion available on its primary U.S. and European revolvers. Cash and cash equivalents remained well above the \$1 billion level that management considers the minimum necessary to meet the company's daily operational requirements through the cycle. The company has no significant debt maturities until 2019, although its European and U.S. revolvers mature in 2016 and 2017, respectively. Going forward, Fitch expects GT to retain a relatively high level of financial flexibility, with strong cash liquidity backed up with significant revolver capacity and positive FCF, although, as noted above, a significant amount of cash is located outside the U.S.
On an EBITDA basis, GT's gross leverage (debt/Fitch-calculated LTM EBITDA) at year-end 2014 was 2.9x, down slightly from 3.0x at year-end 2013, as an increase in EBITDA overcame a slight increase in debt. Lease-adjusted leverage (lease-adjusted debt including off-balance sheet factored receivables/Fitch-calculated EBITDAR) was 3.7x at year-end 2014, down from 3.9x at year-end 2013. Fitch-calculated EBITDA improved to \$2.2 billion in 2014 from \$2.1 billion in 2013 as the EBITDA margin grew to a relatively strong 12.4% from 10.7%. The growth in the EBITDA margin was notable, given that revenue declined 7.2% to \$18.1 billion from \$19.5 billion in 2013. Over the intermediate term, Fitch expects leverage to continue trending down toward the mid-2x range as EBITDA rises and debt declines somewhat. In February 2015, GT made an optional \$200 million prepayment on its \$1.2 billion second-lien secured term loan.
KEY ASSUMPTIONS
--Global tire demand grows modestly, but demand remains weak in Latin America.
--Sales in the near term are negatively affected by the strong U.S. dollar, with some improvement after 2015.
--GT's pension contributions decline significantly in 2015 and beyond due to the near fully funded status of its U.S. plans.
--Capital spending is elevated by recent historical standards, running between \$1.1 billion and \$1.25 billion over the intermediate term, as the company invests in growth initiatives, including its new plant in the Americas.
--Fitch assumes that dividends will rise annually over the next few years.
--The company maintains roughly \$2 billion in cash on its balance sheet, with excess cash used for share repurchases.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Demonstrating growth in tire unit volumes, market share and revenue;
--Producing FCF margins of 2% or better for an extended period;
--Generating sustained gross EBITDA margins of 12% or higher;
--Maintaining leverage near 2.5x for an extended period.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A significant step-down in demand for the company's tires without a commensurate decrease in costs;
--An unexpected increase in costs, particularly related to raw materials, that cannot be offset with higher pricing;
--A decline in the company's cash below \$1.5 billion for several quarters;
--A sustained period of negative FCF;
--An increase in gross EBITDA leverage to above 3.5x for a sustained period, particularly as a result of shareholder-friendly activities.
Fitch has taken the following rating actions on GT and GDTE:
GT
--IDR upgraded to 'BB-' from 'B+';
--Secured bank credit facility affirmed at 'BB+/RR1';
--Secured second-lien term loan affirmed at 'BB+/RR1';
--Senior unsecured notes upgraded to 'BB-/RR4' from 'B/RR5'.
GDTE
--IDR upgraded to 'BB-' from 'B+';
--Secured bank credit facility affirmed at 'BB+/RR1';
--Senior unsecured notes affirmed at 'BB/RR2'.
The Rating Outlook for both companies is Stable.
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