NEW YORK--(BUSINESS WIRE)--Fitch Ratings has stated that it does not expect Jabil Circuit, Inc.'s (Jabil) ratings to be impacted by the company's recent announcement of a $200 million share repurchase program, significantly reduced guidance for fiscal 2014 and business divestiture. Fitch had previously affirmed Jabil's Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook in June 2013.
Jabil's ratings already incorporate expectations for significant occasional volatility in the business, mitigated in part by counter cyclical working capital cash flows. Further, Jabil has more than adequate existing cash to support the $200 million share repurchase program in addition to expectations for solid free cash flow generation through the remainder of fiscal 2014.
On Dec. 17, Jabil announced several developments which are material to the credit:
Jabil announced that it has achieved greater clarity on the timing and restructuring charges related to the cessation of manufacturing services for one of its largest customers, Blackberry Limited. Jabil expects most of its current programs to end in January and Fitch estimates cash restructuring charges to total near $40 million. More importantly, Jabil does not expect to incur material charges related to working capital associated with these programs. The decision to end its relationship with Blackberry was made in September and the associated loss of revenue was already reflected in current expectations.
Fitch believes resolution of the timing and clarity on the associated charges limits the risk of potential additional downside to the disengagement.
Jabil announced an agreement to sell its after-market services business to iQor Holdings for approximately $725 million (including a $50 million note). Jabil expects to receive net proceeds (after-tax and fees) in excess of $600 million. Fitch estimates that this business contributed approximately $100 million in annual EBITDA, or roughly 10% of total EBITDA. The company has not identified specific uses for the proceeds from the sale but Fitch would expect a majority of the cash to be either used to support future growth or returned to shareholders.
Fitch views the divestiture as neutral to the credit as this had not developed into a core service offering of the company. While Fitch believed the after-market services business increased the level of customer engagement and therefore the stickiness of the related engagements, Fitch believes this benefit was limited to a only few customers.
Jabil announced that it expects revenue and earnings for the next fiscal quarter (end January 2014) to be significantly below expectations due to volatility associated with a single large customer which could persist for the remainder of the fiscal year. As a result of the revenue reduction, margins will also decline modestly with lower utilization. Fitch estimates EBITDA margins were roughly 5.9% over the LTM which Fitch expects will decline roughly 30 to 40 basis points for the full fiscal year. Fitch does not expect Jabil to disengage in any way from this customer going forward. Rather, this is simply a function of the highly volatile business Jabil is engaged in with significant customer concentration. Fitch does believe Jabil will look for ways to reduce the associated volatility in the future as management has been keen on minimizing business risk in these types of engagements.
Fitch believes that the volatility Jabil is experiencing, on top of the recent decision to end its relationship with Blackberry is a significant but temporary hit to what had been very strong financial performance at the company. Jabil in recent years has been trying to diversify the business into less volatile areas with longer contractual customer engagements, most notably with its acquisition of Nypro earlier in 2013. Fitch believes that the road forward for Jabil will eventually have reduced volatility. In the meantime, management has shown an ability and willingness to deal rationally with its core business; willing to accept significant customer concentration for acceptable margins that compensate for this level of potential volatility. Management had previously taken steps to reduce some risk with the customer program primarily responsible for the volatility going forward as the customer co-invested in a very substantial capital expenditure program over the past few years. Similarly, Fitch believes the disengagement from Blackberry shows management's proactive approach to risk mitigation as the real danger in that program was the level of working capital investment required from Jabil.
Pro forma for the divestiture of AMS, the disengagement from Blackberry and reduced revenue forecast from the aforementioned customer, Fitch still expects EBITDA to range above $850 million in fiscal 2014. At the low end, this would equate with leverage of approximately 2x or [3x when adjusted for off-balance sheet debt]. These levels are on target with normal expectations for the rating which typically have higher thresholds for temporary disruptions to the business or small strategic acquisitions. Because metrics remains reasonable and liquidity is solid, Fitch does not view the share repurchase program as having a material negative impact on the credit. The company does expect to generate free cash flow before dividends of $400 million to $500 million in fiscal 2014 which further supports the rating in conjunction with the share repurchase program.
Going forward, Fitch would be concerned if share repurchase activity increased to an extent that caused leverage to increase (either directly or through future funding of working capital needs) beyond levels expected for the rating. Fitch notes that periods of volatility in the business leading to significantly lowered equity valuation can increase event risk associated with the credit. If Fitch believed that event risk had increased materially, it is possible the rating outlook could be reduced to Negative.
Rating strengths include the following:
--Strong management team with a track record of delivering best-in-class execution with a disciplined approach to growing the business;
--Advantages in scale as one of the largest of the tier 1 EMS vendors with a balanced global manufacturing footprint, including a strong mix of facilities in low-cost regions;
--Favorable industry trends toward increased manufacturing outsourcing, particularly in the emerging industrial, medical, and clean tech space where Jabil has a leading position;
--Strategic positioning in increasingly complex EMS product offerings including product design, engineering and logistics which enhance the value of EMS partnerships for customers;
--Vertically integrated operations which typically drive higher margins in periods of growth.
Rating concerns include the following:
--The potential for Jabil to pursue further vertical integration capabilities which could lead to additional debt-financed acquisitions or execution risk in an industry with minimal room for execution missteps due to the relatively low profit margin inherent in the business model;
--An intensely competitive environment which pressures profitability across the industry;
--Significant customer concentration risk with Jabil's top five customers accounting for 48% of revenue in fiscal 2012.
Liquidity as of November 30, 2013 was solid consisting primarily of $769 million in cash and approximately $1.2 billion available under a $1.3 billion senior unsecured revolving credit facility expiring in March 2017. Jabil also utilizes two accounts receivable securitization facilities for additional liquidity purposes, both of which are located off balance sheet: a $200 million committed foreign receivables facility and a $200 million committed North American receivables securitization facility, expiring in May 15, 2015 and October 2014, respectively.
Total debt as of November 30, 2013 was $1.8 billion and consisted primarily of:
--Approximately $100 million borrowed under the $1.3 billion revolving credit facility expiring March 2017;
--$307 million in 7.75% senior unsecured notes due July 2016;
--$400 million in 8.25% senior unsecured notes due March 2018;
--$400 million in 5.625% senior unsecured notes due December 2020;
--$500 million in 4.7% senior unsecured notes due July 2022.
Jabil also had approximately $331 million outstanding under its off-balance-sheet European and North American receivables securitization facilities and additional amounts under its accounts receivable sales facilities as of November 30, 2013, which are included in Fitch's adjusted debt calculation.
RATING SENSITIVITY
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Secular shifts or a large customer loss resulting in margin compression with limited visibility as to the potential to return profit margins to historical levels.
Positive: Upside movement in the ratings is limited given Jabil's thin operating margin profile and capital-intensive business model coupled with significant cyclical demand exposure. Greater diversification of the business into markets with significantly lower cyclicality could potentially create an opportunity for positive rating action.
Fitch rates Jabil as follows:
--Long-term IDR 'BBB-';
--Senior unsecured debt 'BBB-'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research
--'Corporate Rating Methodology', dated Aug. 5, 2013.
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective from 8 August 2012 - 5 August 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.