NEW YORK & CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded the Issuer Default Ratings (IDR) for Navistar International Corporation (NAV) and Navistar Financial Corporation (NFC) to 'CCC' from 'B-'. The rating Outlook is Negative. A full list of rating actions is shown at the end of this release.
The rating downgrades and Negative Rating Outlook reflect the company's heightened liquidity risk and negative manufacturing free cash flow (FCF) which could continue into 2013. A significant number of challenges will need to be addressed to avoid liquidity pressures, and FCF could be impaired in the near term by costs related to the implementation of NAV's revised engine strategy, workforce reductions, and possible additional restructuring. Other items that could reduce FCF include lower sales volumes expected in the fourth quarter, and lower margins related to the use of Cummins SCR technology, higher warranty expense for NAV's emissions compliant engines, and the cost of non-conformance penalties (NCPs).
Industry demand and the pace of a possible recovery in NAV's market share are difficult to estimate and could potentially lead to significant negative FCF if economic conditions and customer confidence in NAV's strategy are worse than anticipated. Industry data indicate NAV's market share declined in August. These factors, together with the effectiveness and timing of NAV's transition to its revised emissions technology, will be important in determining the company's near-term financial position and any future rating actions.
Manufacturing debt/EBITDA increased materially to 5.7x as of July 31, 2012, and above 7x adjusted for a new $1 billion term loan in August 2012. Leverage could remain quite high through the next 12-18 months before NAV's revised engine strategy and other potential changes to NAV's operations and strategy become fully effective.
NAV's transition to SCR emissions technology (In-Cylinder Technology Plus, or ICT+) involves execution risk related to integrating the technology with NAV's engines, and with integrating Cummins' 15-liter engine in NAV's trucks. Much of the transition should be completed by mid-fiscal 2013, but delays or higher-than-expected costs could further pressure NAV's liquidity. This risk is mitigated by the fact that NAV's heavy duty engines do not need to be redesigned, with the exception of one sensor. Also, Cummins engineers are co-located at NAV's facilities to assist with the process. This should benefit NAV as Cummins has done similar work to integrate SCR technology for other engine makers. NAV uses Cummins engines in some trucks sold to export markets.
Other risks include emissions credits which NAV estimates will be depleted in 2013 rather than 2012, partly due to lower-than-expected sales volumes, but a gap in timing between depletion and full production of NAV's ICT+ engines could hurt the company's market share and financial results, at least temporarily. This is a particular concern in 10 states that use California Air Resources Board (CARB) standards which do not allow the use of NCPs. In addition, NAV will require approval by the EPA of its reconfigured emissions equipment.
NAV's $1 billion term loan provided additional liquidity while NAV implements its revised engine strategy. A portion of the term loan proceeds were used to repay $238 million outstanding under NAV's ABL facility which was simultaneously reduced to $175 million. NAV's cash at July 31, 2012, adjusted to include the term loan, was slightly more than $1.3 billion. This level of cash should be sufficient to offset negative FCF through the end of fiscal 2012 and into early 2013 while providing an adequate cash cushion. However, NAV's FCF and liquidity could be pressured by the second quarter of fiscal 2013 if industry demand for trucks does not improve, the company's market share does not recover, or costs for the engine transition are substantially larger than offsetting reductions planned by NAV in product development and capital expenditures.
In order to rebuild its operating performance and preserve cash, NAV plans to reduce capital spending, cut back on investments associated with NAV's global expansion, and redirect product development to its engine strategy. Restructuring should also help control NAV's cost structure over the long term, including workforce reductions. NAV estimates these actions will reduce its cost structure by $150 million-$175 million. Immediate benefits will be offset by approximately $50 million-$75 million of restructuring charges.
Fitch could take a negative rating action if NAV's transition to SCR emissions technology is delayed or requires substantial cash expenditures, or FCF does not recover by early fiscal 2013. If sales volumes are low or margins remain pressured, FCF could be impaired, making it difficult to fund capital expenditures, pension contributions and higher interest expense associated with the increase in debt. In addition, four investors have accumulated approximately 56% of NAV's common shares, which introduces uncertainty about long-term operating and financial policies. The ratings could also be negatively affected depending on the outcome of the SEC's investigation of the company's accounting and disclosure practices.
Fitch could take a positive rating action if manufacturing FCF returns toward a breakeven level by the beginning of fiscal 2013, NAV's new engine strategy is implemented on time and at moderate cost, the company's market share begins to recover, and leverage declines materially.
Manufacturing sales increased slightly during the first nine months of 2012, but quarterly trends have been weakening through the year due to economic uncertainty and customer concerns about NAV's engine strategy. NAV's heavy-duty truck orders increased through the first quarter of fiscal 2012 but have since declined, consistent with declines across the industry. Medium-duty truck orders have also been weak. NAV's market share was 24% in the third fiscal quarter, including heavy- and medium-duty trucks and buses, and remains well below the peak level of 36% in 2009. Military sales have also fallen as U.S. defense spending declines.
EBITDA as calculated by Fitch was slightly below break-even through the first nine months of fiscal 2012. The loss reflects higher warranty costs, adjustments of $353 million to pre-existing warranties, commodity costs for steel and rubber, OPEB/drug benefit costs, and advertising expenses. Other charges include restructuring and impairments, ongoing costs to integrate the engine and truck businesses, and the relocation of NAV's headquarters. Margins have also been negatively affected by lower military revenue (trucks and parts), lower engine volumes in Brazil related to pre-buying in the year-earlier period ahead of tighter emissions standards, and a transition to contract manufacturing by the engine business in Brazil for one of its large customers (MAN).
NAV's manufacturing FCF is constrained by recurring pension contributions. NAV estimates it will be required to contribute at least $141 million annually from 2013 to 2015. The estimate is lower than earlier estimates as a result of MAP-21 legislation passed in July 2012 which defers required contributions but does not reduce the obligation. Any reduction in near-term contributions would lead to higher contributions in subsequent years depending on future asset returns and discount rates. NAV contributed $112 million during the first nine months of 2012 and expects to contribute $45 million in the fourth quarter. It also expects to make OPEB contributions of $17 million in the quarter. NAV's net pension obligations totaled nearly $1.8 billion (approximately 57% funded) at the end of 2011.
The Recovery Rating (RR) of '1' for Navistar Inc.'s $1 billion term loan supports a rating of 'B', three levels above NAV's IDR, as the loan can be expected to recover more than 90% in a distressed scenario based on a strong collateral position. The '5' RR for NAV's senior unsecured debt results in a rating of 'CCC-', one notch below the IDR, and reflects poor recovery prospects in a distressed scenario. An RR of '6' for the senior subordinated convertible notes reflects a lower priority relative to NAV's senior unsecured debt.
The downgrades of NFC's IDR and bank facility rating reflect the direct rating linkage between NFC and NAV, given their inter-related activities and the core nature of NFC's business to that of NAV. Furthermore, the linkage reflects the potential that under a severe stress scenario, NAV may seek to extract capital and/or unencumbered assets from NFC.
Fitch views NFC's performance, asset quality and leverage levels as neutral to NAV's rating. NFC's performance has not changed materially compared to Fitch's expectations, but its financial profile is likely to be affected over the long term by lower than expected volumes at NAV, and NFC's strong linkage to its manufacturing parent. Profitability continued its slight decline in the nine months ended July 31, 2012 due to the run-off of NFC's retail portfolio. Fitch believes future profitability at NFC will be directly affected by the general operating and financial condition of NAV, as well as the performance of the wholesale receivables portfolio going forward.
Asset quality continues to improve and provisioning has declined as NFC focuses on its wholesale portfolio, which historically has experienced lower loss rates relative to the retail portfolio. Absent material dividends upstreamed to the parent, Fitch expects NFC's leverage to improve and stay below historical levels due to reduced overall financing needs. In June 2012, NFC completed a $501.6 million securitization and the proceeds were used to repay outstanding borrowings on a previous securitization and a portion of its revolving bank credit facility. In addition, NFC completed the refinancing of a $750 million wholesale facility in August 2012. Fitch believes the refinancing of NFC's debt facilities may help to mitigate potential near-term liquidity concerns at NFC.
Fitch believes NFC is core to NAV's overall franchise, and the IDR of the finance subsidiary is directly linked to that of its ultimate parent due to the close operating relationship and importance to NAV, as substantially all of NFC's business is connected to the financing of new and used trucks sold by NAV and its dealers. The relationship between NAV and NFC is formally governed by the Master Intercompany Agreement. Also, there is a requirement referenced in NFC's credit agreement requiring Navistar, Inc. or NAV to own 100% of NFC's equity at all times.
As of July 31, 2012, Fitch's ratings cover approximately $3 billion of debt at NAV, adjusted for the new $1 billion term loan and ABL repayment, and $2.3 billion of outstanding debt at the Financial Services segment, the majority of which is at NFC.
Fitch has downgraded the following ratings:
Navistar International Corporation
--Long-term IDR to 'CCC' from 'B-';
--Senior unsecured notes to 'CCC-'/'RR5' from 'CCC+'/ 'RR5';
--Senior subordinated notes to 'CC'/'RR6' from 'CCC'/'RR6'.
Navistar, Inc.
--Long-term IDR to 'CCC' from 'B-';
--Senior secured bank term loan to 'B'/'RR1' from 'BB-'/'RR1'.
Cook County, Illinois
--Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'CCC-' from 'CCC+'.
Illinois Finance Authority (IFA)
--Recovery zone revenue facility bonds (Navistar International Corporation Project) series 2010 to 'CCC-' from 'CCC+'.
Navistar Financial Corporation
--Long-term IDR to 'CCC' from 'B-';
--Senior secured bank credit facilities to 'CCC-'/'RR5' from 'CCC'/ 'RR5'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Finance and Leasing Companies Criteria' (Dec.12, 2011);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (Aug. 14, 2012);
Applicable Criteria and Related Research:
Finance and Leasing Companies Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=659834
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686476
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