Fitch Affirms Caterpillar's IDR at 'A'; Outlook Stable
KEY RATING DRIVERS
The affirmation of CAT's ratings reflects the company's liquidity and operating flexibility that should enable it to mitigate the impact of the cyclical downturn in its end markets, including mining which is expected to enter the fourth year of a downturn in 2016. Credit metrics have weakened only slightly until recently, including debt/EBITDA of just under 1.4x as of June 30, 2015 and free cash flow (FCF)/total adjusted debt of 18%, but Fitch expects leverage and cash flow measures will deteriorate further as the downturn continues.
Fitch estimates debt/EBITDA could increase to approximately 1.75x by the end of 2016 (above Fitch's previous estimate of slightly higher than 1.5x) and FCF/total adjusted debt could decline toward 10%. These levels are near the weak end of the cyclical range expected by Fitch, but Fitch expects they will remain better than the levels seen during the downturn in 2008 and 2009. Since then, CAT has improved its ability to adjust production and cost structure in response to cycles, although cycles remain a key driver of the company's performance.
Fitch estimates manufacturing FCF will decline to slightly more than \\\$1 billion in 2015 compared to \\\$3.7 billion in 2014 as a result of weaker operating results, restructuring charges, and a smaller positive impact from lower working capital requirements. FCF could decline further after 2015, but Fitch expects FCF to remain positive. CAT's manufacturing FCF would be higher when including dividends from CAT's Financial Products business which Fitch classifies as investing cash flows. These dividends totaled \\\$470 million in 2014 and \\\$250 million through the first nine months of 2015. FCF as defined by Fitch also excludes changes in receivables sold to CFSC.
The decline in demand for CAT's machinery and equipment reflects the end of a strong commodity cycle and challenges facing China and a number of other developing regions that drive infrastructure investment. As a result, there is a risk that CAT's credit metrics will remain weak beyond 2016 without a clear line-of-sight for an improvement in financial results and credit metrics. Fitch could consider a negative rating action in the event that credit metrics appear unlikely to begin recovering after 2016.
Other concerns include large share repurchases including \\\$2 billion initiated in 2015, IRS litigation, and potential additional support required for CAT's Financial Products business if its performance were to deteriorate. An adverse outcome from tax litigation could result in a large tax payment, although the timing would be uncertain. These concerns are partly offset by CAT's ongoing actions to manage inventories, combined with a planned \\\$2 billion restructuring program that should mitigate pressure on margins and cash flow and allow CAT to position itself for an eventual recovery.
CAT's revenue and EBITDA margins have declined since CAT's mining and construction end-markets peaked in 2012, reflecting several trends including low prices for commodities that affect demand for CAT's mining equipment, slow construction activity outside the U.S., and the negative impact of low oil prices on orders for CAT's engines and for construction equipment in oil-producing regions. Fitch expects these trends to continue through 2016.
Although margins will be pressured by lower revenue, Fitch expects they will be higher than during previous downturns due to long term operating improvements, a flexible cost structure, and the recent implementation of a multi-year \\\$2 billion restructuring program that is expected to reduce costs by \\\$1.5 billion annually when completed.
The ratings incorporate CAT's global presence, competitive positions in its machinery, energy and transportation markets, broad product lines, diverse customer base, and an established and well-capitalized independent dealer network. CAT has a high level of financial flexibility and is capable of generating strong FCF. These factors are important in coping with highly cyclical end markets and supporting the company's Financial Products business which primarily includes CFSC.
The ratings for CAT consider CFSC on an equity basis.
CATERPILLAR FINANCIAL SERVICES CORPORATION (CFSC)
CFSC's ratings are equalized with CAT's ratings, reflecting Fitch's view of CFSC as a core subsidiary of CAT based on the 100% ownership, shared brand name, importance of CFSC to achieving CAT's strategic objectives and the Support Agreement between the two entities.
Beyond these support-driven considerations, Fitch also considers CSFC's solid operating performance and very strong asset quality performance counterbalanced by elevated leverage levels relative to stand-alone finance companies, but consistent with similarly rated captive finance peers, as well as its reliance on wholesale funding sources.
CFSC's balance sheet leverage, which is calculated by Fitch as debt-to-tangible equity, is expected to be within CFSC's historical range of 7.0x-8.0x as of Sept. 30, 2015, and consistent with other captive finance peers but higher than many stand-alone finance companies. Fitch does not anticipate any significant changes in CFSC's overall capital structure. Should funding requirements increase in a distressed market, Fitch believes CAT would inject additional capital into the finance arm, as necessary, to manage CFSC's overall leverage profile.
KEY RATING DRIVERS - Caterpillar Financial Australia Limited (CFAL), Caterpillar International Finance Limited (CIF) and Caterpillar Finance Corporation (CFC)
CFAL, CIF and CFC are wholly-owned subsidiaries of CSFC. The ratings of the subsidiaries reflect the unconditional and irrevocable guarantee provided by CFSC for full repayment of obligations under the subsidiaries' various borrowing facilities. The guarantee is viewed as the strongest form of parental support, which in Fitch's view, enhances the rating linkages between CFSC and its subsidiaries. As a result, the IDRs and issue ratings of the subsidiaries are linked to those of CFSC.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for CAT's manufacturing business include:
--The cyclical downturn continues through 2016 in CAT's mining, energy, and international construction equipment markets; a significant recovery does not occur until 2017 or later.
--EBITDA margins decline into 2016 due to the impact of lower revenue on operating leverage and an unfavorable sales mix.
--Planned restructuring contributes to cost savings of \\\$1.5 billion annually to be realized over several years beginning in 2016.
--FCF declines to slightly more than \\\$1 billion in 2015 as a result of weaker operating results and a smaller positive impact from lower working capital requirements. FCF could decline further after 2015, but Fitch expects FCF to remain positive.
--Cash deployment for share repurchases will be minimal after 2015 until CAT's performance improves.
--CAT maintains its market share through the current industry downturn.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a downgrade include:
Caterpillar Manufacturing Business
--Credit metrics are consistently weak for more than a few quarters during mid-cycle periods, including funds from operations (FFO) adjusted leverage above 2.0x or debt/EBITDA above 1.5x. During periods of cyclical weakness, credit metrics could exceed these levels for two to three years. At the long end of this timeframe, Fitch expects metrics would be only slightly outside the mid-cycle range. Fitch expects mid-cycle FFO adjusted leverage will be near 2.0x or below and debt/EBITDA will be near 1.25x or below;
--Market share declines materially in key product lines or geographic regions;
--Margins remain permanently lower after end market demand improves;
--CAT experiences poor execution on its operating strategies including restructuring and inventory and supply chain management.
Cyclicality in CAT's machinery markets limits the potential for a positive rating action. However, developments that Fitch would view as positive for CAT's credit profile include:
--An increase in the company's geographic and product diversification and in the proportion of relatively stable parts and services revenue;
--Meaningful market share growth in emerging markets;
--Lower peak financial leverage during down-cycles (debt/EBITDA well below 1.5x) and stronger FCF through the business cycle;
--Effective product development.
CFSC and Designated Subsidiaries
Positive rating momentum would be limited by Fitch's view of CAT's credit profile, as CFSC's ratings and Outlook are linked to that of its parent. Fitch cannot envision a scenario where the captive would be rated higher than its parent.
Conversely, negative rating actions for CFSC could be driven by a change in the perceived relationship between CAT and CFSC. For example, if Fitch believed that CFSC had become less core to CAT's strategic operations and/or adequate financial support was not provided to the captive finance company in a time of need. In addition, consistent operating losses, a material change in balance sheet leverage, and/or deterioration in the company's liquidity profile, any of which alters CFSC's perceived risk profile and/or requires the injection of regular financial support from CAT, could also drive negative rating actions.
LIQUIDITY
CAT's liquidity (excluding CFSC) at Sept. 30, 2015, as calculated by Fitch, totaled \\\$7 billion, including cash of \\\$4.8 billion and credit facility availability of approximately \\\$2.75 billion (as of June 30, 2015), offset by \\\$516 million of current maturities of long-term debt and \\\$12 million of short-term debt. CAT estimates its overseas cash would be available for use in the U.S. without incurring significant U.S. taxes.
Long-term debt is well-distributed, with annual maturities not exceeding \\\$900 million during the next five years. Other cash requirements include pension contributions that CAT estimates at \\\$180 million in 2015, down from \\\$520 million in 2014. At the end of 2014, pension plans were underfunded by \\\$4.4 billion (79% funded).
Credit facility availability of \\\$2.75 billion as of June 30, 2015 is the internal allocation of CAT's consolidated \\\$10.5 billion of facilities to the equipment business. CAT can revise the allocation of these facilities between CFSC and its equipment businesses at any time. The facilities were amended in September 2015 and consist of a \\\$3.15 billion 364-day facility that expires in September 2016, a \\\$2.73 billion facility that expires in September 2018, and a \\\$4.62 billion facility that expires in September 2020.
Under intercompany agreements, as of June 30, 2015, CAT may borrow up to \\\$1.29 billion from CFSC (\\\$431 million outstanding) and CFSC may borrow up to \\\$2.3 billion from CAT (\\\$1.1 billion outstanding) on a short-term basis. In addition, CFSC provides a \\\$2 billion committed credit facility to CAT which expires in 2019.
CFSC also purchases, at discount, dealer and customer receivables from CAT. Outstanding receivables balances purchased by CFSC totaled nearly \\\$3 billion at June 30, 2015. Fitch classifies changes in these amounts as financing cash flows at CAT's manufacturing business.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Caterpillar Inc. (CAT)
--IDR at 'A';
--Senior unsecured bank credit facilities at 'A'.
--Senior unsecured notes at 'A';
--Short-term IDR at 'F1';
--Commercial paper (CP) at 'F1'.
Caterpillar Financial Services Corporation
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Senior unsecured notes at 'A';
--Senior unsecured bank facilities at 'A';
--CP at 'F1'.
Caterpillar Financial Australia Limited
--Short-term IDR at 'F1';
--CP at 'F1'.
Caterpillar International Finance Limited
--Long-term IDR at 'A';
--Senior unsecured notes at 'A';
--Senior unsecured credit facilities at 'A'.
Caterpillar Finance Corporation
--Long-term IDR at 'A';
--Senior unsecured credit facilities at 'A'.
The Rating Outlook is Stable.
The ratings cover approximately \\\$9.5 billion of debt at CAT as of Sept. 30, 2015 and \\\$28 billion of unsecured debt at CFSC, before considering intercompany loans.
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