Fitch Affirms American Axle's IDR at 'BB-'; Outlook Revised to Positive
AAM's ratings apply to a \\$523.5 million secured revolving credit facility, a \\$138.8 million secured term loan A and \\$1.35 billion in senior unsecured notes. The Rating Outlooks for both AXL and AAM have been revised to Positive from Stable.
KEY RATING DRIVERS
The Positive Outlook revision for AXL and AAM is driven by Fitch's expectations for a further strengthening of the auto supplier's credit profile over the intermediate term. Also contributing to the Positive Outlook revision is Fitch's expectation that the customer, platform and geographic diversification of the company's book of business will continue to grow over the next several years, reducing the company's reliance on General Motors Company's (GM) full-size pickup and sport utility vehicle programs. Although increased diversification will likely result in somewhat lower margins, Fitch views this as an appropriate trade-off for reduced exposure to a single vehicle program.
AXL's credit profile improvement over the next couple of years will be driven, in part, by revenue growth exceeding global light vehicle production as the company's continues to expand its book of business with new customers and programs, leading to stronger FCF generation that will provide it with meaningful financial flexibility. However, beyond 2017, the loss of a portion of AXL's content on the next GM light truck platform will likely constrain revenue and put some additional pressure on margins. Nonetheless, even with the loss of that business, Fitch expects margins to remain relatively strong and FCF to remain solidly positive over the longer term, providing the company with ongoing financial flexibility and the ability to further reduce leverage.
Fitch's concerns include the ongoing concentration of AXL's revenue base, despite its increased diversification; the potential for operational issues to arise with the substantial amount of launch activity expected over the intermediate term, much of it involving new customers and technologies; and the sensitivity of the company's credit metrics to changes in its operating performance. Although AXL's book of business will become increasingly diversified over the intermediate term, Fitch expects GM to remain the company's largest customer by a wide margin for a number of years. In addition, AXL will remain heavily exposed to GM's light truck program, so any decline in demand for those vehicles will have an outsized impact AXL's financial performance.
The company's focus on diversification, while a credit positive overall, increases the risk of potential startup issues as the company increasingly works on new products with new customers. Several years ago, the company experienced several quarters of negative FCF in part due to significant launch issues, although recent launches have gone smoothly. Partly as a result of AXL's relatively small size, its credit protection metrics remain quite sensitive to fluctuations in operating performance, and a steep decline in production or potential launch issues could lead to a rapid deterioration in its credit metrics.
AXL recently announced that it was selected by GM as a target supplier under GM's Strategic Sourcing Program (SSP) to provide axles and driveline equipment for future generations of GM's full-size light truck and SUV program. This has the potential to lock in AXL for future generations of the program that could span more than a decade. However, in conjunction with its achieving target supplier status, AXL expects GM to shift 25% of the content that AXL currently supplies for the program to another source. The loss of this high-margin business is a credit negative, and Fitch estimates that the lost future business accounts for roughly 13% of AXL's current revenue base. GM has not yet announced when the next generation of its full-size trucks will enter production, but Fitch estimates that it will be at least three years before AXL sees the effect of the lost business, giving the company time to reallocate the freed up capacity to other new programs. The company has noted that the long-term clarification of the remaining GM business, along with the flexibility of its manufacturing equipment, will give it the ability to bid more competitively for new programs as it will not need to add incremental capacity to take on that business. Fitch believes the company has the ability to replace most of the lost business, but the new programs will likely carry lower margins, given the significant scale efficiencies that AXL realizes on the products it supplies for GM's full-size light truck and SUV program.
Free cash flow (FCF) (calculated as net cash from operations less gross capital expenditures) in the 12 months (LTM) ended June 30, 2015, was \\$196 million, equating to a relatively solid FCF margin of 5.1%. AXL's FCF-generating capability has improved significantly over the past two years, as the company has produced positive quarterly FCF in six of the last eight quarters. LTM FCF at June 30, 2015 was also substantially higher than the \\$38 million in FCF with a 1.1% FCF margin that the company produced in the LTM ended June 30, 2014. Lower capital expenditures of \\$194 million in the June 30, 2015 LTM period versus \\$234 million in the year-earlier period contributed to the improvement, but much of the increase has been the result of higher production volumes and continued work on cost efficiencies. The year-over-year decline in capital spending was largely due to incremental investments that the company made in 2014 to support changes in GM's light truck program.
Going forward, Fitch expects the company's capital expenditures to run at a more typical level of about 4.5% to 5% of annual revenue. Over the intermediate term, Fitch expects AXL to produce annual FCF in the \\$150 million to \\$200 million range with the normalized capital spending levels, volume-related contribution margin improvement and continued working capital management. Fitch believes the company will continue to prioritize organic revenue growth and leverage reduction when assessing potential uses for its FCF. However, the company could also consider acquisition opportunities to further diversify its customer base or geographic diversification. Fitch expects that any acquisitions would complement the company's existing product offerings, rather than shift it into completely new lines of business. Longer-term, AXL could also look to return some cash to shareholders, although the company currently appears primarily focused on growing its business and strengthening its balance sheet.
AXL's overall liquidity remains adequate to meet the company's cash obligations. Cash and cash equivalents at June 30, 2015, totaled \\$301 million, up from \\$129 million at June 30, 2014, and AAM had \\$506 million available on its \\$523.5 million secured revolver after accounting for \\$17 million in letters of credit. The company has no meaningful debt maturities due until 2018 when the majority of AAM's secured Term Loan A comes due. Combined with Fitch's expectations for positive FCF generation, Fitch expects AXL's cash and revolver availability to remain more than adequate to cover its intermediate-term liquidity needs.
AXL's leverage (debt/Fitch-calculated EBITDA) declined slightly during the LTM ended June 30, 2015, to 3.0x from 3.2x in the year-earlier period, primarily as a result of higher EBITDA as debt remained relatively flat. Overall, Fitch-calculated EBITDA rose to \\$512 million in the LTM ended June 30, 2015 from \\$487 million in the year-earlier period, while debt was about \\$1.5 billion at the end of both periods. Funds from operations (FFO) adjusted leverage was 3.6x at June 30, 2015, down from 3.9x at June 30, 2014. Fitch expects leverage to decline further over the intermediate term as the company makes amortization payments on its Term Loan A and as EBITDA increases on higher business levels. The company could also look to prepay a portion of its Term Loan A beyond the normal amortization schedule without penalty to further reduce leverage. Excluding the effect of any term loan prepayments or early debt redemptions, Fitch expects EBITDA leverage to decline to the high-2x range by year end 2015 and to decline further, to the mid-2x range over the following two years. Over the same period, Fitch expects FFO adjusted leverage to decline to the low-3x range.
Similar to many other defined benefit plans sponsored by U.S. companies, the funded status of AXL's pension plans declined in 2014, primarily due to a combination of lower discount rate assumptions and revised mortality tables. As a result, AXL's pension plans were 87% funded at year-end 2014, down from 94% funded at year end 2013. However, at year end 2014, the net liability was only \\$95 million, which Fitch views as manageable given the company's liquidity position and FCF generating capabilities. As such, Fitch does not currently view the funded status of AXL's defined benefit pension plans as a meaningful credit risk.
The Recovery Rating of 'RR1' assigned to AAM's secured revolving credit facility and secured term loan A reflects their collateral coverage, which includes virtually all the assets of AXL and AAM, leading to expected recovery prospects in the 90% to 100% range in a distressed scenario. The Recovery Rating of 'RR4' assigned to AAM's senior unsecured notes reflects Fitch's expectation that recovery prospects would be average, in the 30% to 50% range, in a distressed scenario.
KEY ASSUMPTIONS
--Global auto production rises in the low-single-digit range over the intermediate term;
--U.S. light vehicle sales approach 17 million in 2015 and remain near that level for the next several years;
--AXL's new product programs tied to its backlog of new business roll out smoothly over the intermediate term;
--EBITDA margins decline somewhat over the next several years, consistent with a more diversified book of business;
--Revenue growth and margins are constrained in 2018 as the company replaces lost GM full-size light truck and SUV business with new programs at a lower margin;
--Capital spending over the intermediate term is at normalized levels of about 5% of revenue;
--The company uses cash on hand to fund amortization payments and the final maturity of its term loan A in 2018;
--Over the intermediate term, excess cash is used for relatively small acquisitions or is returned to shareholders.
RATING SENSITIVITIES
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 FCF margins of 2% or higher;
--Sustained EBITDA leverage below 3x;
--Sustained FFO adjusted leverage in the low 3x range;
--Successfully replacing the lost 25% of the GM full-size light truck and SUV revenue with new business.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Significant production inefficiencies and associated cash burn tied to the start-up of new programs;
--A rise in EBITDA leverage to above 3.5x for a sustained period;
--A rise in FFO adjusted leverage to 4x or higher for a sustained period;
--A sustained decline in the EBITDA margin to below 10%;
--Sustained negative free cash flow generation;
--An unexpected prolonged disruption in the production of GM's full-size pickups and SUVs.
Fitch has affirmed the following ratings and assigned Recovery Ratings as follows:
AXL
--IDR at 'BB-'.
AAM
--IDR at 'BB-';
--Secured revolving credit facility rating at 'BB+/RR1';
--Secured term loan A rating at 'BB+/RR1';
--Senior unsecured notes rating at 'BB-/RR4'.
The Rating Outlook has been revised to Positive from Stable.
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