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Fitch Affirms Michelin at 'A-'; Outlook Stable
June 8, 2017 / 3:57 PM / 3 months ago

Fitch Affirms Michelin at 'A-'; Outlook Stable

(The following statement was released by the rating agency) LONDON/PARIS, June 08 (Fitch) Fitch Ratings has affirmed Compagnie Generale des Etablissements Michelin's (Michelin) and Compagnie Financiere Michelin SCmA (CFM) Long-Term Issuer Default Ratings (IDRs) at 'A-'. The Outlooks on the IDRs are Stable. CFM's and Michelin Luxembourg SCS's long-term senior unsecured ratings are also affirmed at 'A-'. Fitch also assigned a long-term senior unsecured rating of 'A-' to debt issued by Michelin. CFM is the group's finance arm and the intermediate holding entity for Michelin's non-domestic operations. Fitch has also affirmed Michelin's and CFM's Short-Term IDRs as well as Michelin Luxembourg SCS's short-term debt at 'F2'. We have also assigned a debt rating of 'F2' to Michelin's short-term debt. The rating action reflects the group's solid and defensive business profile and our expectations that Michelin will maintain robust credit metrics in the foreseeable future. KEY RATING DRIVERS Defensive and Premium Positioning: Michelin derives a majority of its sales from the replacement market, which is more stable and profitable than the original equipment business. In addition, a large part of the revenue comes from the premium tyre segment, which is traditionally higher margin and faster growing than the overall market. Geographic diversification is also gradually increasing as a result of Michelin's bold investments in emerging markets. Free Cash Flow Weak but Stable: The company's free cash flow (FCF) margin has been quite low for the ratings, at less than 2% on average over the past 10 years. This is because robust underlying funds from operations (FFO) have been largely absorbed by ambitious capex, earmarked chiefly to finance growth in emerging markets, and a generous payout ratio. Equity-friendly actions have also included an active share buy-back programme coming after FCF and weighing on net cash generation. However, earnings and FCF held up during the economic recession and auto industry crisis in 2008-2009, and Fitch expects they will be sustained in future. We also acknowledge the solid cash generation excluding the effects from commodity prices on inventory. We project FCF to be hit by unfavourable working capital movements, the one-off interest payment on the zero coupon Oceane convertible bond and increasing dividends in 2017, leading to a decline in the FCF margin below 1%, but to rebound in 2018-2019 between 3.5%-4.5%. Record Margin: Michelin posted a record group operating margin of 12.9% in 2016, driven by solid earnings at its passenger car division which offset the weakening of the truck business. However, Michelin's profitability remains below that of several close peers as its margins are hindered by its cost structure and the bias of its production base towards France and the rest of Europe compared with other peers, as well as overcapacity issues in several plants. Measures to Boost Profitability: The group restructured operations to streamline its cost base and we believe that profitability will be improved in coming years. We expect a gradual increase in group operating margin towards 13%-13.5% by 2019 from additional cost savings, productivity gains, production reorganisation and price increases. These should offset unfavourable raw material prices, possible adverse foreign-exchange movements and cost inflation as well as higher depreciation and amortisation following the substantial increase in capex. Raw Materials, Currency Exposure: Michelin has a high exposure to foreign exchange due to currency translation risks and the difficulty in exactly matching production and sales. In addition, raw materials (RM) are a major part of Michelin's cost structure and their prices' historical high volatility has had a significant effect on operating margin. A high portion of this cost is typically hedged and covered by RM clauses, but such clauses and hedges only protect for a limited period. Nonetheless, Michelin has an excellent track record of passing on RM price increases to its customers. The group has again announced several price increases recently to reflect the increase in commodity costs in the past year. Financial Flexibility: Positive FCF has enabled the group to reduce debt steadily since the 2009 recession while FFO improved continuously. FFO adjusted net leverage declined from 3x at end-2009 to about 1x since 2013 in spite of significant capex spending and acquisitions. We expect it to remain below 1x through 2019, although we believe that acquisitions or other unplanned cash outflows may lead adjusted net leverage to increase temporarily above 1x. Financial flexibility is also supported by the group's ability to lower or delay investment in case of greater-than-planned earnings weakening. DERIVATION SUMMARY Michelin's strong business profile is supported by its position in the tire industry, which is less volatile and cyclical than other segments of the auto supply sector. The group is a leading and recognised player in its sector and compares adequately with large and global suppliers, including Robert Bosch GmbH, Continental AG, Delphi Automotive PLC and Faurecia S.A. Similar to the highest-rated auto suppliers, Michelin has a good geographical diversification, does not rely on any specific auto manufacturer and has an advanced technology leadership in segments it covers. With an EBIT margin of more than 12%, profitability is at the top end of the sector but Michelin's free cash flow margin is somewhat lower than most peers rated in the 'A' and 'BBB' category such as Caterpillar Inc. (A/Negative), Continental (BBB+/Stable), BorgWarner, Inc. (BBB+/Stable) and Delphi (BBB/Stable). However, cash generation remains strong on an absolute basis and has been stable historically. Adjusted net leverage is around 1x, higher than Bosch (F1 Short-Term IDR) and BorgWarner but similar to Continental and Delphi. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to increase by nearly 5% in 2017 and between 3%-4% in 2018-2019. - Group operating margin to increase towards 13.5% through 2019, as margins of the PC division strengthen gradually to 13.5%, Trucks recover slightly and remain at 10-10.5% and Specialty remains around 19%. This includes a neutral net effect from pricing and raw material price developments and the increasing gains from cost savings. - Substantial working capital outflow in 2017 followed by a moderate recovery in 2018-2019. - Capex intensity to decline continuously to about 7.5% of sales by 2019 as the peak of investments is passed. - About EUR100 million of share buybacks per year completing a pay-out ratio of about 35%. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -FCF margin above 4%. -FFO adjusted net leverage below 1x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FCF margin below 2%. -FFO adjusted net leverage above 1.5x. - EBIT margin below 12%. LIQUIDITY Healthy Liquidity: Liquidity is supported by EUR1.5 billion of readily available cash at end-2016, according to Fitch's adjustment for minimum operational cash of EUR525 million and EUR83 million of restricted cash as reported by the group. Michelin has also access to a EUR1.5 billion committed and unutilised credit lines at end-2016. This is largely covering EUR1.2 billion in short-term debt, which include EUR150 million raised through commercial paper programmes. The maturity profile is not an immediate risk, with no major debt maturing before June 2019 (unsecured euro notes). Contact: Principal Analyst Aurelien Jacquot Associate Director +33 1 4429 9137 Supervisory Analyst Emmanuel Bulle Senior Director +34 9 3323 8411 Fitch Ratings Espana S.A.U. Av. Diagonal 601 08028 Barcelona Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email: francoise.alos@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary Summary of Financial Statement Adjustments: -Material item viewed as non-operating: restructuring costs. -Derivative instruments liabilities are removed from gross debt. 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