Fitch Affirms Navistar at 'CCC'; No Expected Rating Impact from Proposed Secured Term Loan Increase
NAV announced earlier today it plans to refinance Navistar, Inc.'s $697.5 million senior secured term loan facility including increasing the amount to $1,040 million and extending the maturity date to 2020. The proposed changes do not materially change Fitch's view of NAV's credit profile. The new term loan would increase liquidity and reduce scheduled annual debt maturities that would not exceed approximately $200 million until 2019.
Fitch still expects NAV's financial performance to improve further as it streamlines its manufacturing operations and gradually regains market share with the completion of its revised engine strategy. However, the ratings are constrained in the near term by NAV's free cash flow (FCF), which Fitch expects will be negative in 2015, and NAV's market share, particularly for heavy duty trucks, which has recovered more slowly than expected. In addition to these concerns, the U.S. Department of Justice recently filed a lawsuit on behalf of the U.S. Environmental Protection Agency seeking penalties of up to $291 million related to NAV's use of engines during 2010 that did not meet emissions standards. In the event of an adverse outcome, a large payment would reduce liquidity and slow an improvement in NAV's credit measures.
KEY RATING DRIVERS
Liquidity continues to be a key rating concern. Fitch believes existing liquidity, before considering the proposed increase in the secured term loan, is adequate to fund the company's operations in the near term, but annual FCF remains negative and NAV has relied on funding from NFC to maintain high cash balances. Until NAV further increases EBITDA margins and negative FCF becomes positive, NAV will be sensitive to any adverse developments in its end markets or operating performance. Manufacturing cash balances and marketable securities in 2015 have remained above $700 million ($784 million at April 30, 2015), and Fitch expects cash will increase by the end of fiscal 2015 ahead of the first quarter when seasonal FCF typically is at its weakest level.
At April 30, 2015 debt/EBITDA was over 7x which represented an improvement compared to the past three years. Fitch does not include intercompany loans from NFC in manufacturing debt, and leverage would be higher when including these liabilities. NAV's use of intercompany funds from NFC includes loans and dividends. The net amount of loans and dividends provided to NAV in the first half of 2015 totaled $87 million. Loans include used truck inventory financing utilized by NAV to facilitate new truck sales. The company estimates future inventories will peak at $425 million compared to $375 million at April 30, 2015.
Manufacturing free cash flow (FCF) was negative $447 million in 2014 as calculated by Fitch (FCF excludes dividends from Financial Services and changes in intercompany used truck financing). Fitch estimates FCF will improve in 2015 but still be negative at approximately negative $200 million to $250 million, partly due to material cash spending for warranties and pension contributions. Fitch had expected FCF to become positive in 2015, but NAV's sales will be weaker than anticipated and market share is recovering more slowly. In addition, used truck inventories are increasing. Warranty cash spending exceeds warranty expense and continues to be high, particularly for discontinued EGR-only engines. However, warranty expense fell by approximately half in 2014 and cash spending should decline as EGR engines exit their warranty period. In addition, NAV does not incur engine warranty expense for trucks sold with Cummins engines installed.
Pension contributions represent a recurring use of cash. NAV expects to contribute $113 million in 2015, including $62 million in the first half of the year. NAV has reduced its planned contributions as permitted under the Highway and Transportation Funding Act of 2014 which extended relief from funding rules through 2017. NAV's net pension obligations were $1.4 billion at FYE Oct. 31, 2014, unchanged compared to the prior year.
The company's EBITDA margin as calculated by Fitch was 3.5% at April 30, 2015 on a last-12-months basis. Margins are increasing, albeit unevenly, on a quarterly basis and should increase further as NAV restructures and streamlines its manufacturing and engineering operations, completes the implementation of its engine strategy, and as warranty expense declines. Cost improvements include lower material costs, engineering, SG&A, and the elimination of non-core manufacturing facilities. The pace of EBITDA margin expansion will partly depend on sales volumes, pricing and market share in NAV's highly competitive industry.
NAV's efforts to rebuild its operating performance are supported by solid cyclical demand in North American heavy and medium duty truck markets where NAV's business is concentrated. Strong industry production reflects economic growth, high truck fleet utilization, and replacement of an aging fleet. Risks include weak demand in certain overseas markets and a mature demand cycle in North America that could peak in 2015. An eventual industry downturn could hinder NAV's long-term recovery, but the current cycle has been less pronounced than past cycles which could provide some support for future truck production.
Orders in NAV's traditional markets (Class 6-8 trucks and school buses) have been down in recent periods. NAV's backlog at April 30, 2015 was slightly higher than one year earlier and 4.6% above the end of fiscal 2014. Market share has not recovered as quickly as anticipated, but customer acceptance may improve as trucks with SCR engines demonstrate a record of performance. NAV's retail market share of medium duty trucks in the second quarter of 2015 was materially higher, at 27%, compared to the previous three quarters that averaged 20%, but the sustainability of the recovery in NAV's market share will need to be demonstrated. NAV's market share in heavy duty trucks remains low but is above trough levels.
The Recovery Rating (RR) of '1' for Navistar, Inc.'s senior secured term loan facility supports a rating of 'B', three levels above NAV's IDR, as Fitch expects the loan would recover more than 90% in a distressed scenario based on a strong collateral position. The proposed increase to the term loan does not materially affect estimate recoveries for the term loan or for unsecured or subordinated debt. The 'RR4' for senior unsecured debt reflects average recovery prospects in a distressed scenario. The RR '6' for senior subordinated convertible notes reflects a low priority position relative to NAV's other debt.
NAVISTAR FINANCIAL CORPORATION
Fitch believes NFC is core to NIC's overall franchise, and the IDR of the finance subsidiary is directly linked to that of its ultimate parent due to the close operating relationship and importance to NIC, as substantially all of NFC's business is connected to the financing of new and used trucks sold by NAV's dealers. The relationship is formally governed by the Master Intercompany Agreement, as well as a provision referenced under NFC's credit agreement requiring NAV or NIC to own 100% of NFC's equity at all times.
NFC's operating performance and overall credit metrics are viewed by Fitch to be neutral to NIC's ratings. The company's performance has not changed materially compared to Fitch's expectations, but its financial profile remains tied to NIC's operating and financial performance. Total financing revenue increased for the six-months of 2015 (6M15) ended April 30, 2015, resulting from the continued growth and penetration of wholesale financing to dealers partially offset by the expected decline of the retail portfolio balance. The average finance receivables balance increased to $1.6 billion at April 30, 2015 compared to $1.3 billion one-year prior.
Asset quality of the underlying receivables portfolio remains stable, reflecting the mature retail portfolio, which continues to run-off. Charge-offs and provisioning volatility has also been stable as NFC continues to focus on its wholesale portfolio, which historically has experienced lower loss rates relative to the retail portfolio.
NFC's leverage remains relatively low compared to its captive peers but has risen in recent quarters due to the upstreaming of $125 million in dividends to the parent in the first half of 2015. During the period, NAV also borrowed an additional $42 million from NFC on a used truck loan but reduced a separate intercompany loan by $80 million. Balance sheet leverage, as measured by total debt to equity, was 3.9x as of April 30, 2015. Fitch believes NFC's leverage is appropriate and consistent with other captive finance companies. NIC continues to utilize the strength of NFC's balance sheet to enhance liquidity at the parent company, including re-establishing dividends and intercompany borrowing between NIC and NFC.
The equalization of the bank credit facility at 'CCC/RR4' (reflecting average recovery prospects) with the IDR indicates that given current balance sheet encumbrances, the creditors under the facility are effectively in an equal position with unsecured note-holders. This incorporates Fitch's expectation that NFC will continue to utilize the securitization markets to fund its operations, which could consequently lead to the level of unencumbered assets falling to such an extent that they may only be sufficient to support repayment of the senior secured credit facility. Fitch would view positively, a greater proportion of unsecured debt in the funding profile, as it would enhance the company's financial flexibility in a stressed scenario.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for NAV's manufacturing business include:
--Revenue is lower in 2015 than 2014 due to the termination of NAV's Blue Diamond Truck joint venture with Ford in the third fiscal quarter of 2015, a decline in exports, pricing pressure and product mix;
--Market share recovers gradually in NAV's heavy and medium duty truck markets but remains well below peak levels;
--Industry demand for heavy and medium duty trucks reaches a cyclical peak in 2015;
--FCF improves but remains negative. Fitch expects FCF to become positive by mid-to-late 2016 on an annualized basis;
--Margins increase from low levels;
--Warranty cash costs continue to decline.
RATING SENSITIVITIES
Navistar International Corporation
Future developments that may, individually or collectively, lead to a positive rating action include:
--Consistently higher EBITDA margins lead to positive FCF and lower leverage;
--NAV's market share recovers to a level around 20% or higher for heavy duty trucks and above 30% for medium duty trucks;
--Liquidity improves sufficiently to reduce reliance on funding from NFC.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Manufacturing cash and marketable securities balances decline to a level near NAV's estimated minimum required operating cash level of approximately $500 million;
--Manufacturing EBITDA margins as calculated by Fitch fail to improve materially from approximately 3.5% on an LTM basis at April 30, 2015;
--FCF does not become positive on an LTM basis within 12-18 months;
--There is a material adverse outcome from litigation including the SEC's investigation into the company's accounting and disclosure practices and a lawsuit by the EPA concerning NAV's used of emission credits dating to 2010.
Navistar Financial Corporation
NFC's ratings are linked to those of its parent. Therefore, positive rating momentum will be limited by Fitch's view of NIC's credit profile. However, negative rating action could be driven by a change in the perceived relationship between NFC and its parent. Additionally, a change in profitability leading to operating losses, a material change in leverage and/or deterioration in the company's liquidity profile could also yield negative rating actions.
The rating of the senior secured bank credit facility is sensitive to changes in NFC's IDR, as well as the level of unencumbered balance sheet assets in a stress scenario, relative to outstanding debt.
LIQUIDITY
Liquidity at NAV's manufacturing business as of April 30, 2015 included cash and marketable securities totaling $784 million (net of BDT and BDP joint venture cash and restricted cash). NAV also has an undrawn $175 million ABL facility. Liquidity was offset by current maturities of manufacturing long term debt of $115 million. In addition to the ABL, NAV uses an Intercompany Used Truck Loan from NFC under which $223 was outstanding at April 30, 2015. NAV also had an outstanding intercompany loan of $190 million from NFC at April 30, 2015, a portion of which NAV repaid in the first half of fiscal 2015 with dividends received from NFC.
Fitch deems NFC's current liquidity to be adequate given available resources and the company's continued success in securitizing originated assets but notes that liquidity may become constrained if the parent materially increases its reliance on NFC to find operations. During 6M15, NFC renewed a $100 million trade receivables securitization and extended the maturity date of the revolving note of a wholesale receivables transaction. Fitch views favorably, NFC's ability to refinance a portion of its borrowing facilities and access the capital markets at reasonable terms, which should mitigate some potential near-term liquidity concerns.
As of April 30, 2015 debt at NAV's manufacturing business totaled $3 billion, including unamortized discount, and nearly $2.3 billion at the Financial Services segment, the majority of which is at NFC.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the ratings for NAV and its affiliates as follows:
Navistar International Corporation
--Long-term IDR at 'CCC';
--Senior unsecured notes at 'CCC'/'RR4';
--Senior subordinated notes at 'CC'/'RR6'.
Navistar, Inc.
--Long-term IDR at 'CCC';
--Senior secured term loan facility at 'B'/'RR1'.
Cook County, Illinois
--Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 at 'CCC'.
Illinois Finance Authority (IFA)
--Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 at 'CCC'.
Navistar Financial Corporation
--Long-term IDR at 'CCC';
--Senior secured bank credit facility at 'CCC'/'RR4'.
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