Fitch Affirms Continental at IDR 'BBB'; Outlook Positive
The rating action is driven by Continental's robust business profile at the high-end of the 'BBB' rating category and its solid performance in 1H15. The Positive Outlook reflects our expectations that the group's financial profile will further improve towards our positive rating guidelines by 2017. In particular, we expect funds from operations (FFO) adjusted net leverage to decline further to below 1x at end-2017 from 1.2x at end-2014 and the free cash flow (FCF) margin to remain above 3% through to 2017.
KEY RATING DRIVERS
Sound Profitability, Growth Prospects
The Positive Outlook reflects Continental's solid performance in 1H15 and Fitch's expectations that the group's business and financial profile will strengthen further. We expect revenue growth to benefit from a recovering European auto market and market share gains.
Profitability is strong and has been fairly resilient in face of the cyclicality and volatility of the automotive supply industry. Fitch expects group operating margins to remain above 11% in the foreseeable future despite our assumption of an erosion of the rubber business's operating margin towards 15%-15.5% in 2016, from 16.8% in 2014. However, we project that the automotive division's profitability will remain above 8.5% in the foreseeable future.
Strong Business Profile
The ratings reflect Continental's large manufacturing operations, global footprint, top-ranking positions in the markets in which the group operates and solid end-market diversification. Continental derives about 30% of its sales from the less volatile non-original equipment (OE) business, and it plans to increase this share to about 40% in the medium term. Continental is also well positioned in rapidly growing segments, including vehicle connectivity, fuel efficiency and autonomous driving.
Limited Acquisition Risk
The auto supply sector is in gradual consolidation and we expect Continental to play a leading role given its size, financial power and bold strategy to maintain leadership in its segments. The USD1.9bn acquisition of Veyance in February 2014 and Elektrobit Automotive for EUR600m in 2015, illustrate Continental's participation in the sector consolidation and its external growth momentum. The group also has a positive track record in target selection, and conservative financing and integration of its acquisitions.
Strong Free Cash Flow
Healthy free cash flow (FCF) generation is supported by a robust underlying FFO margin, which we expect to remain between 11.5% and 12.5% in the foreseeable future, versus 11% in 2013 and below 10% in previous years. FFO will more than cover working capital needs, capex outflows of EUR2.3bn-2.7bn per annum and dividend pay-out ratio of just less than 30%. We expect FCF margin to remain above 3% through to 2017.
Leverage Decreasing
We expect robust FCF to rapidly absorb the effect of the Veyance and Elektrobit Automotive acquisitions. In addition, improving FFO should enable FFO-adjusted net leverage to remain at 1.2x at end-2015 and decrease to less than 1.0x by end-2017.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Continental include:
- Revenues to increase by more than 14% in 2015, including the acquisition of Veyance (approximately EUR1.3bn in extra revenue) and approximately 6%-7% in 2016 and 2017;
- Operating margins to remain between 11% and 11.5% in 2015-2017;
- Working-capital outflows of EUR300m-400m p.a.;
- Capex of more than 6% of revenue on average in 2015-2017;
- Dividend pay-out ratio between 25% and 30%.
RATING SENSITIVITIES
Negative: Future developments that could, individually or collectively, lead to a downgrade include:
- EBIT margin below 7% (2014: 11%, 2015E: 11.7%, 2016E: 11.2%, 2017E: 11.3%)
- FCF margin below 2% (2014: 4.6%, 2015E: 3.9%, 2016E: 3.1%, 2017E: 3.4%)
- FFO-adjusted net leverage above 1.5x (2014: 1.2x, 2015E: 1.2x, 2016E: 1.0x, 2017E: 0.8x)
Positive: Future developments that could, individually or collectively, lead to positive rating action include:
- EBIT margin above 9%
- FCF margin above 3%
- FFO-adjusted net leverage below 1x
LIQUIDITY
Continental's liquidity is healthy, supported by EUR1.5bn of readily available cash according to Fitch's adjustments for minimum operational cash of EUR0.7bn and EUR0.3bn of restricted cash at end-June 2015. Liquidity is further supported by the group's syndicated loans, which consist of a term loan of EUR1.5bn maturing in April 2016 and a revolving credit line of EUR3bn, maturing in April 2020. Total committed and unutilised credit lines were EUR4.1bn at end-June 2015.
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