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Fitch Rates CNH Industrial 'BBB-'; Publishes CNH Industrial Capital's Rating
October 24, 2017 / 8:18 AM / a month ago

Fitch Rates CNH Industrial 'BBB-'; Publishes CNH Industrial Capital's Rating

(The following statement was released by the rating agency) BARCELONA/LONDON, October 24 (Fitch) Fitch Ratings has assigned CNH Industrial N.V. (CNHI) and published US-based CNH Industrial Capital LLC's (CNHI Capital) Long-Term Issuer Default Ratings (IDR) of 'BBB-' Fitch has also published CNH Industrial Capital's Short-Term IDR of 'F3'. The Rating Outlook is Stable. A complete list of ratings is available at the end of this commentary. The ratings of CNHI reflect its strong business profile, including leading market positions in commercial vehicles and agricultural equipment and diversification by end-market and geography. The ratings also reflect operating margins that are commensurate with Fitch's expectations for 'BBB' category capital goods companies and deleveraging prospects. The ratings for CNHI Capital incorporate support from CNH Industrial. KEY RATING DRIVERS CNH Industrial Diversified Business Profile: CNH is one of the largest and most diversified capital goods OEMs globally, with strong market share in nearly every region it serves. CNHI is the leader in Europe and among the three largest players in North America and Latin America for agricultural equipment. In commercial vehicles, which primarily serve EMEA, CNH maintains a top three position for light and medium commercial trucks. The company's largest geographic market is EMEA, which represented 56% of 2016 sales, followed by North America (21%). Deleveraging Trend: CNHI's funds from operations (FFO) adjusted net leverage declined to 2.8x at end-2016 from above 5x at end-2014, driven by management's focus on deleveraging, CNHI demonstrated a solid track record of deleveraging, despite significant stress in the agriculture and construction equipment markets. Fitch forecasts FFO net leverage to decrease below 2.5x in the short term, driven by stable profitability and continued positive FCF generation. Capex Constrains FCF Generation: Fitch forecasts lower free cash flow (FCF) margins at around 1.5% in its four-year forecast period, on expectations for increased regulatory spending. Fitch forecasts working capital will increase with gradual volume growth, and expects capex to be higher than the past three-year averages, driven by Stage V emission standards investment needs. CNHI's FCF margin improvement in 2015 and 2016 to 4% was driven by better working capital management and lower regulatory capex. However, Fitch believes that lower working capital needs are not necessarily a structural improvement, but a result of stressed market conditions leading to inventory adjustments, which could reverse in the short- to medium-term. Profitability Lags Peers: CNHI's profitability is lower than higher-rated peers', because of a higher cost base, smaller scale and different product mix. Fitch forecasts an improvement in EBIT margins to around 4%-4.5% in the medium term from 2.6% in 2016, as we expect continued weak pricing conditions in the construction and commercial segments to be offset by the successful implementation of CNHI's cost savings programme. End-markets Still Depressed: Fitch does not expect a sharp recovery in agriculture and construction equipment markets despite signs of bottoming out with orders from Latin America and North America slightly picking up. Fitch believes that farm income in the US and EMEA is at historical lows and limited credit availability in Latin America could further constrain demand, which drives our low single-digit growth assumptions for the next four years. Consolidation in agriculture markets may limit large capex by buyers and therefore delay sizeable orders, although this will be offset by more light machinery orders. Cash Allocation Strategy: Fitch believes that CNHI has limited headroom for M&A and shareholder-friendly policies compared with its peers and will continue channelling available cash for debt repayment and capex. Fitch expects that a material increase in cash outflows to shareholders could tighten leverage metrics and limit further acquisitions that could improve CNHI's market shares. Any change in CNHI management's cash allocation strategy to make higher dividend payments or undertake large M&A, leading to significant increase in leverage metrics, could lead to significant deterioration in credit quality. Regulatory Risks: Similar to the auto industry, trucks and agricultural equipment manufacturers are prone to political and policy risks. The management of global emissions legislation remains an important issue for the industry as a whole. Fitch incorporates increased capex related to emission standards in its projections for CNHI, and believes that potential moderate fines and penalties will be manageable within the current rating. CNHI Capital Ratings Equalised with Parent's: CNHI Capital's ratings are equalised with CNHI's ratings, reflecting Fitch's view of CNHI Capital as a core subsidiary of CNHI. This view is supported by 100% ownership by CNHI, shared brand name, the importance of CNHI Capital in achieving the group's strategic objectives and a support agreement between the two entities. The support agreement requires CNHI to maintain at least 51% ownership of CNHI Capital, maintain CNHI Capital 's net worth at no less than USD50 million, and maintain CNHI Capital 's fixed-charge coverage at no less than 1.05x on a quarterly basis. Standalone Strengths and Weaknesses: Beyond these support-driven considerations, Fitch also factors in CNHI Capital's consistent operating performance, solid asset quality and sufficient liquidity. These factors are counterbalanced by CNHI Capital's elevated leverage relative to standalone finance companies and a mostly secured funding profile. Strong Asset Quality: Asset quality metrics at end-1H17 were solid, despite an uptick in delinquencies. Delinquencies greater than 30 days past due amounted to 0.75% compared with 0.67% in the prior year period. Net write-offs were USD22.3 million or 0.2% of average managed receivables in 1H17 compared with USD20.9 million or 0.18% a year ago. The increase in the percentage of net write-offs was largely driven by a shrinking portfolio. The allowance for credit losses amounted to USD85.2 million, or 0.8% of total finance receivables, which compares favourably with peers'. Given strong asset quality performance over the last several years, metrics are expected to normalise in the medium term. Fitch believes CNHI Capital's loss reserves are sufficient to cover potential losses on the subsidiary's receivables. Operating Performance Weaker: Operating performance has declined since 2014 amid weaker economic conditions that have contributed to lower origination volumes. Pretax income was USD111.5 million in 1H17, down 27.6% from the prior year. This translated to pre-tax return on average assets (ROAA) of 1.62% for 1H17, which is below the four-year average of 2.37%. The declines were primarily due to a smaller average portfolio, increased depreciation expense on operating leases and a larger provision for credit losses. Despite recent volatility and weakness, Fitch expects the company will remain profitable in the near- to medium-term. High Leverage: CNHI Capital's leverage, as defined by debt-to-tangible equity, was 9.4x at end-1H17, little changed from end-2016, but down from 9.6x at end-2015. Leverage is high relative to captive finance peers and higher than many standalone finance companies. Fitch would view a sustained increase in CNHI Capital's leverage negatively. Secured Funding Still Substantial: CNHI Capital's funding profile and diversification has steadily improved over the past few years, with increased utilisation of unsecured debt markets. Still, the company remains reliant on secured debt for a meaningful portion of its funding, with approximately 65% of funding in the form of ABS debt and secured revolving (warehouse) facilities as of end-1H17. Secured funding, as a percentage of total funding, remains high relative to CNHI Capital's captive peers. Fitch expects that CNHI Capital will continue to opportunistically increase its proportion of unsecured debt, which Fitch views favourably as it improves funding flexibility. The unsecured debt rating is equalised with the company's Long-Term IDR, which reflects the availability of an unencumbered asset pool and adequate recovery prospects under a stress scenario. DERIVATION SUMMARY Fitch views CNHI's business profile as being in line with investment grade peers, both in terms of geographic and end-market diversification. CNHI's business profile is characterised by market leading positions in most of the company's products, a diverse product range, broad end-customer base and a good geographical breakdown of activities. CNHI's profitability lags higher-rated peers' all across segments, due to a higher cost base, smaller scale, lower market shares and a different product mix. We believe CNHI's financial profile does not match higher-rated peers such as John Deere CO and Caterpillar Inc., which are around the 'A' rating median but remains commensurate with a 'BBB' rating category in our rated capital goods universe. Despite recent deleveraging, CNHI's leverage metrics are higher than AB Volvo (BBB/Stable) and Deere (A/Stable), with limited flexibility. However FFO net leverage is expected to remain commensurate with the 'BBB' category (around 2.5x) through our four-year forecast period, driven by our expectations of FCF generation increase of 1%-2%. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Modest revenue growth at 2% per year; - EBITDA margin growing to 9.5% by 2020 from 9.1% in 2016; - Dividend pay-out at 50% of net income; - Capex at 3% of revenue (2.1% at end-2016); and - Slight working capital outflow at an average of USD127 million per year over 2017-2020. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action CNH Industrial -FFO adjusted net leverage below 2x -EBIT margins over 7%. -FCF margin above 2% through the cycle. -Stable market shares, combined with a sufficient track record or confidence that the company can meet the quantitative guidelines above. CNHI Capital Positive rating momentum for CNHI Capital would be limited by Fitch's view of CNHI's credit profile, as CNHI Capital's ratings and Outlook are linked to those of its parent. Fitch cannot envision a scenario where the captive would be rated higher than its parent. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action CNH Industrial -Negative FCF margins through the cycle. -FFO adjusted net leverage above 3x. -EBIT margin below 4%. -Increased funding needs for CNHI Capital, leading to a significant stress in leverage metrics. CNHI Capital CNHI Capital's long-term and short-term IDRs are equalized with those of CNH Industrial and are expected to move in tandem. However, negative rating action could be driven by the following: --A change in the perceived relationship between CNHI and CNHI Capital, for example, if Fitch believes that CNHI Capital is no longer core to CNHI's strategic operations or that adequate financial support will not be provided to the captive finance company in a time of need;. --Significant asset quality deterioration at CNHI Capital; --Consistent operating losses; -- A material change in balance sheet leverage; and -- Deterioration in the liquidity profile. LIQUIDITY CNH Industrial Healthy Liquidity: Fitch views the liquidity position of CNHI as solid. At end-2016, the company had unrestricted cash of USD3.9 billion and undrawn committed credit facilities of USD2.9 billion, more than covering its short-term debt of USD1.3 billion. The main funding source of CNHI is its EUR10 billion medium-term notes programme, which the company taps into regularly. This also provides the company with an even maturity schedule with annual maturity of less than USD2 billion. CNHI Capital CNHI Capital's liquidity is sufficient given consistent operating cash flow generation, available cash on hand of USD159 million as of end-1H17 and USD1.1 billion undrawn credit facilities. Unsecured debt maturities are manageable, with USD1.2 billion of debt maturing in 2018. The company paid USD140 million in dividends to its parent in 1H17, USD290 million in 2016 and USD170 million in 2015. FULL LIST OF RATING ACTIONS CNH Industrial N.V. --Long-Term IDR assigned at 'BBB-'; Stable Outlook The following ratings have been published: CNH Industrial Capital LLC --Long-Term IDR 'BBB-'; Stable Outlook --Short-Term IDR 'F3' --Senior unsecured debt 'BBB-' Contact: CNH Industrial N.V. Principal Analyst Alexey Evstratenkov Associate Director +44 203 530 1089 Supervisory Analyst Cigdem Cerit Associate Director +34 93 467 8840 Fitch Ratings Espana Av. Diagonal, 601, planta 2 08028 Barcelona Committee Chairperson Emmanuel Bulle Senior Director +34 93 323 8411 CNH Industrial Capital LLC Primary Analyst Sean Pattap Senior Director +1-212-908-0642 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Jared Kirsch, CFA Associate Director +1-212-908-0332 Committee Chairperson Christopher Wolfe Managing Director +1-212-908-0771 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments -Fitch restricts cash equivalent to 3% of revenue as cash deemed necessary for operational needs, and not available for debt repayments. -Operating leases are capitalised using a 8x multiple, and debt is adjusted accordingly. -Fitch adjusts for debt deconsolidated to CNHI's financial services business so that debt-to-equity at this division does not exceed 4x. For 2016 this results in approximately EUR2 billion of debt being allocated into the industrial business. -Fitch does not consider expenditure related to buyback and leases as capex, and captures these items as other investing cash outflows, hence having no impact on our FCF calculations. 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. 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