Fitch Ratings has affirmed the Issuer Default Rating (IDR) for
Tenneco Inc. (TEN) at 'BB+'. In addition, Fitch has affirmed TEN's
secured revolving credit facility and secured Term Loan A ratings
at 'BBB-' and assigned both a recovery rating of 'RR1'. Fitch has
also upgraded TEN's senior unsecured notes rating to 'BB+' from
'BB' and assigned the notes a recovery rating of 'RR4'. The Rating
Outlook is Stable. TEN's ratings apply to a $1.2 billion secured
revolving credit facility, a $300 million secured Term Loan A and
$725 million in senior unsecured notes. A full ratings list follows
at the end of this release.
KEY RATING DRIVERS
TEN's ratings continue to be supported by the company's market
position as a top global supplier of emission control and vehicle
suspension components, with a strong presence in both the original
equipment and aftermarket segments. In addition, tightening
regulations governing commercial truck and off-highway vehicle
emissions in a number of global jurisdictions have led to increased
growth opportunities and higher profitability for the company.
TEN's credit profile is characterized by slowly declining, but
somewhat variable, leverage and adequate liquidity. However, free
cash flow margins are relatively low.
Primary risks to the company's credit profile include industry
cyclicality, volatile raw material costs and variability in fuel
prices. Cyclical risk is mitigated somewhat by the increasing
diversification of the company's customer base and improving cost
structure, as well as ever-tightening global emissions regulations,
which will drive growth in the market for emission control products
independent of global economic conditions. Also mitigating risk and
supporting near-term liquidity is a lack of material debt
maturities until 2019. Volatile fuel prices present a risk because
TEN's equipment on smaller and more fuel efficient vehicles tends
to be less profitable. As with other auto suppliers, TEN seeks to
minimize the effect of volatility in raw material prices by passing
along a substantial portion of the change in its material costs to
its original equipment customers.
Another meaningful risk is the potential for an adverse outcome
in the ongoing antitrust investigation of TEN being conducted by
the European Commission (EC) and the U.S. Department of Justice
(DOJ). Details of the investigation, the potential timing of any
resolution and the ultimate exposure to TEN are currently unknown,
but the DOJ's willingness to grant the company conditional leniency
through the Antitrust Division's Corporate Leniency Policy is
encouraging. The Leniency Policy limits TEN's exposure as long as
the company self- reports matters to the DOJ and continues to
cooperate with the DOJ's investigation. Nonetheless, a particularly
adverse outcome from the investigation by either the EC or the DOJ
could lead to a negative rating action.
TEN's secured revolver and secured Term Loan A both have a
recovery rating of 'RR1' and are rated one-notch above the
company's IDR, reflecting their substantial collateral coverage,
which includes virtually all of the company's U.S. assets and up to
66% of the stock of its first-tier foreign subsidiaries. Based on
Fitch's recovery rating criteria, 'BBB-' is the highest issue
rating that may be assigned to an issuer with an IDR of 'BB+' or
lower. Fitch has assigned a recovery rating of 'RR4' to TEN's
senior unsecured notes, reflecting Fitch's revised expectations for
an average recovery in a distressed scenario. The assignment of an
'RR4' recovery rating has led to an upgrade of the rating on TEN's
senior unsecured notes to 'BB+'.
Fitch expects demand for TEN's Clean Air products to remain
relatively strong over the intermediate term as global emissions
requirements continue to tighten. In particular, increasingly
strict regulations for commercial trucks and off-road equipment, as
well as for locomotives and water-borne vessels, will contribute to
revenue growth that outpaces the growth of global light vehicle
production. Fitch also expects TEN's revenue stream to become
increasingly diversified over the next several years as the
company's product penetration in non-traditional segments
increases. New technologies in the company's Ride Performance
division, including active and semi-active suspension systems, will
also contribute to growth in revenue and profitability, although
Fitch continues to expect emissions control products to be the
larger contributor to TEN's sales growth over the intermediate
term. Despite these improvements, in the near term, sales are
likely to be negatively affected by foreign exchange translation as
a result of the strong U.S. dollar, which will mask much of the
growth associated with higher business levels.
Fitch expects the higher margins generated by TEN's commercial
and off-highway business to combine with improvements in the
company's cost structure to support further margin growth over the
intermediate term. Fitch's calculated EBITDA margin was 8.6% in
2014, but excluding substrate sales (which are largely passed
through to the company's customers with little markup), the EBITDA
margin would have been a relatively strong 11.1% for the year. In
2014, substrate pass-through revenue totaled $1.9 billion, or 23%,
of the company's $8.4 billion in total revenue. Since larger
engines require more substrates in their emissions control systems,
substrate pass-through revenue is likely to increase as a
percentage of the company's overall revenue over the intermediate
term. This could result in some overall margin dilution that could
offset a portion of the higher profitability associated with
emissions control products for larger engines.
Fitch expects TEN's credit profile to strengthen modestly over
the intermediate term on a combination of higher business levels
and continued discipline on controllable costs. EBITDA gross
leverage will likely decline modestly during 2015, potentially to
below 1.5x by year end, and it is likely to decline further over
the next couple of years. However, Fitch expects leverage to
fluctuate through the year as the company uses its revolver and
other short-term borrowings to offset typical seasonal swings in
its cash flows. Debt levels will decline somewhat as the company
makes normal amortization payments on its Term Loan A, but with net
leverage near the company's target at year-end 2014, further debt
reduction is likely to be a low priority. TEN ended 2014 with net
leverage, according to its own calculation, of 1.1x, versus its
target of 1.0x. This suggests that the company will deploy free
cash flow primarily toward shareholder-friendly activities going
forward, such as the $350 million share repurchase program
announced in February 2015.
TEN's free cash flow was ($17) million in 2014, primarily due to
increased capital spending to support the company's growth
initiatives. However, in 2013 the company produced positive free
cash flow of $220 million, the strongest level of free cash flow in
years. In 2015, Fitch expects free cash flow to turn positive
again, but it is likely to remain under pressure from relatively
high capital spending. The company also has fully utilized it U.S.
tax NOLs, which led to higher cash tax payments in 2014 and will
continue to pressure free cash flow going forward. Over the past
several years (with the exception of 2014), TEN's free cash flow
margins have generally been in the low-single digit range, even
after adjusting for substrate revenue, and Fitch expects the
company to continue producing low-single-digit free cash flow
margins over the intermediate term. These low free cash flow
margins are a significant factor weighing on TEN's IDR and are well
below those of higher-rated auto suppliers.
Despite the negative free cash flow, TEN's overall liquidity
position remained adequate at year-end 2014. The company ended the
year with $282 million in cash and cash equivalents, augmented by
nearly full availability on its $1.2 billion secured revolver. (The
company had $34 million in letters of credit backed by the revolver
at year-end 2014.) However, most of TEN's cash was located outside
the U.S. at year-end 2014. Going forward, Fitch expects cash
liquidity to remain near the current level, with any excess cash
targeted toward the company's recently announced $350 million
three-year share repurchase program. Although TEN is likely to
maintain only modest cash balances in the U.S., the company does
repatriate cash when needed to fund certain U.S. activities. TEN
has not been an acquisitive company in recent times, but Fitch
expects the company would dial back on share repurchases to support
its liquidity position in the event that it undertook an
acquisition.
TEN's credit profile strengthened modestly in 2014 on continued
improvements in the company's operating performance, which offset a
slight increase in debt. Revenue increased 5.7% to $8.4 billion as
the effect of higher business levels was partially offset by
negative foreign exchange translation. Fitch's calculated EBITDA
margin was 8.6% in 2014, up from 8.1% in 2013. As of year-end 2014,
TEN's EBITDA leverage (debt/Fitch-calculated EBITDA) was 1.6x, down
from 1.7x at year-end 2013, while debt rose to $1.13 billion from
$1.10 billion. Lease-adjusted leverage (lease-adjusted debt/
EBITDAR) was 2.3x at year-end 2014. Fitch's calculation of lease
adjusted leverage includes the impact of operating leases as well
as $153 million in off-balance sheet borrowings on the company's
European accounts receivable securitization facilities. FFO
adjusted leverage at year-end 2014 rose slightly to 3.3x from 3.1x
at year-end 2013, while FFO fixed charge coverage declined to 3.4x
from 3.8x.
The funded status of TEN's global pension plans declined in
2014, falling to 78% at year-end 2014 from 84% a year earlier. In
the U.S., the funded status declined to 75% from 82% at the end of
2013. As with many corporate plans, the year-over-year decline in
the funded status was primarily due to a combination of lower
long-term interest rates and revised mortality assumptions. TEN
used a 4.1% discount rate to value its U.S. projected benefit
obligation in 2014, down from 4.8% in 2013. On a dollar basis,
TEN's global plans were underfunded by only $205 million ($115
million in the U.S.), which Fitch views as manageable given the
company's liquidity position and free cash flow prospects. TEN has
estimated that required cash contributions to its global pension
plans will be $31 million in 2015, down from actual contributions
of $46 million in 2014.
KEY ASSUMPTIONS
--Global economic conditions continue to improve at a modest
pace, leading to low-single digit growth in global auto
production.
--In addition to increased auto production, TEN's revenue
benefits from higher commercial vehicle and off-road equipment
demand as emissions regulations in these segments continue to
tighten many global markets.
--With the improving vehicle production volumes and increased
penetration, TEN's revenue and profitability grow, but negative
foreign exchange masks much of the near-term revenue
improvement.
--Capital spending remains elevated by historical standards over
the intermediate term to support new product wins and growth in the
company's manufacturing footprint.
--Debt maturities are refinanced through over the next several
years.
--Share repurchases total of $350 million over the next three
years, and the company continues with share buybacks following the
expiration of the current program.
--The company's cash remains near the year-end 2014 level though
the intermediate term.
RATING SENSITIVITIES
Positive: Further developments that may, individually or
collectively, lead to a positive rating action include:
--An Increase in TEN's value-added free cash flow margin to
about 3% on a consistent basis;
--A decline in FFO adjusted leverage to 2.5x or lower;
--An increase in FFO fixed charge coverage to 5x or higher.
Negative: Further developments that may, individually or
collectively, lead to a negative rating action include:
--A severe decline in global vehicle production that leads to
reduced demand for TEN's products;
--A decline in TEN's value-added free cash flow margin to below
1% for an extended period;
--An increase in FFO adjusted leverage to 4x or higher;
--A decline in FFO fixed charge coverage to 3x or lower;
--An adverse outcome from the antitrust investigation that lead
to a significant decline in liquidity or an increase in
leverage.
Fitch has taken the following rating actions on TEN with a
Stable Rating Outlook:
--IDR affirmed at 'BB+';
--Secured revolving credit facility rating affirmed at 'BBB-'
and assigned a recovery rating of 'RR1';
--Secured Term Loan A rating affirmed at 'BBB-' and assigned a
recovery rating of 'RR1';
--Senior unsecured notes rating upgraded to 'BB+/RR4' from
'BB'.
Additional information is available at
'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Corporate Rating Methodology: Including Short-Term Ratings and
Parent and Subsidiary Linkage (May 28, 2014);
--Tenneco Inc. - Ratings Navigator (Nov. 26, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and
Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982065
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Fitch Ratings Inc.Primary AnalystStephen BrownSenior
Director+1-312-368-3139Fitch Ratings Inc.70 West Madison
StreetChicago, IL 60602orSecondary AnalystEric C. AuseSenior
Director+1-312-606-2302orCommittee ChairpersonCraig D.
FraserManaging Director+1-212-908-0310orMedia RelationsAlyssa
Castelli, +1-212-908-0540alyssa.castelli@fitchratings.comElizabeth
Fogerty, +1-212-908-0526elizabeth.fogerty@fitchratings.com