FRANKFURT & PARIS & LONDON--(BUSINESS WIRE)--Fitch Ratings has upgraded France-based Compagnie Generale des Etablissements Michelin's (Michelin) and Compagnie Financiere Michelin's (CFM) Long-term Issuer Default Ratings (IDR) and senior unsecured ratings to 'BBB' from 'BBB-'. The Outlooks on the Long-term IDRs are Positive. Fitch has also upgraded both entities' Short-term IDRs to 'F2' from 'F3' and Michelin's hybrid bond rating to 'BB+' from 'BB'. CFM is the group's finance arm and the intermediate holding entity for Michelin's non-domestic operations.
The upgrades reflects Fitch's view that Michelin's performance demonstrated resilience throughout the sharp downturn in the global vehicle and tyre markets in 2008/2009, with funds from operations (FFO) increasing continuously over the past three years. On the back of the high-margin tyre replacements business segment, which represents about three-quarters of Michelin's sales, and with the strong recovery of the highly cyclical and relatively low-margin original equipment (OE) automotive business, the company achieved 20.8% year on year (yoy) sales growth and 13.4% unit volume growth during fiscal year 2010 (FY10) resulting in a 15.9% EBITDAR margin. This is expected to remain stable over the coming years. The strong recovery in 2010 and a successful EUR1.2bn rights issue also significantly improved Michelin's adjusted net leverage to 1.1x from 2.2x at FYE09, while total adjusted gross debt declined to 1.9x at FYE10 from 2.9x at FYE09.
The Positive Outlook reflects Fitch's expectations that Michelin's operating margin could rise sustainably to 10% or more in the short to medium term, notably as a result of investments in productive capabilities in China and India, as well as the fact that free cash flow (FCF) could grow significantly after 2011. In line with Michelin, Fitch expects unit sales to grow by at least 6.5% in 2011 and by 3.5% per annum thereafter.
Fitch's primary concerns are the impact of rising raw material prices and the aggressive pricing pressures from original equipment manufacturers (OEMs) in the OE tyre markets. Rubber, which is Michelin's primary cost component, doubled in price in 2010, partly due to revived strong demand from emerging markets and as a result of poor rubber plantation harvests in Southeast Asia. This was mitigated by Michelin's strong reputation and brand recognition, which allows the company to adjust tyre prices to match the increasing cost of raw materials (especially rubber and metals). As at FYE10, 75% of Michelin's additional costs of EUR1.5bn, had been mitigated by tyre price adjustments in 2010 and 2011, as well as implementing raw material indexation clauses. However, rubber prices are expected to increase further (16.3% during January 2011 vs end-December 2010). Fitch believes that a lag in price adjustments to raw material cost increases during 2011 may lead to negative pressure on Michelin's 2011 profitability, but from 2012 onwards, notably thanks to the raw material indexation clauses, Fitch considers it is likely Michelin will achieve an EBIT margin target of 10% or more.
Michelin intends to spend EUR1.35bn between 2011 and 2015 on a tyre production plant in China. Although this capex can be considered discretionary, competitive pressures from peers, many of whom have expressed similar intentions, may force Michelin to act. FCF may decline to negative levels in 2011 as a result of the exceptionally high capex of EUR1.6bn in 2011, dividend payment, and lag in price adjustments to raw material price increases. Michelin has provided similar guidance for 2011, with positive FCF expected between 2011 and 2015. Fitch expects FCF to return to above 5% of sales in the medium term.
Additional information is available at www.fitchratings.com.
The issuer did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure.
Applicable criteria, 'Corporate Rating Methodology', dated 13 August 2010, 'Equity Credit for Hybrids & Other Capital Securities', dated 25 June 2008, are available at www.fitchratings.com.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646
Equity Credit for Hybrids & Other Capital Securities - Amended
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493112
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