Standard & Poor's Ratings Services revised its outlook on Italian conglomerate Fiat Industrial SpA (Fiat Industrial) to stable from negative. At the same time, we affirmed our 'BB+/B' long- and short-term corporate credit ratings on the group.
The outlook revision reflects 2011 results that were slightly better than we had anticipated, and our view that Fiat Industrial's diversification should offset our expectations of weaker truck sales in the important Southern European market over the next few quarters.
Fiat Industrial comprises the nonautomotive activities demerged in January 2011 from Italian auto manufacturer Fiat SpA (BB/Watch Neg/B): agricultural and construction equipment manufacturer CNH Global N.V. (BB+/Negative/--), truck maker Iveco SpA., and FPT Industrial.
We believe that falling demand and margins in the group's truck division will be counterbalanced by the positive trend in global agricultural and construction equipment demand that will support CNH's sales and operating results.
Under our base-case scenario we assume that CNH's agricultural equipment division should benefit from low single digit global demand growth. We expect this division's operating margin to continue to strengthen from 2011. CNH's construction equipment business will also gain from the positive trend in global demand, probably more than the agricultural equipment division. But the effect of this positive momentum may be lessened if the division does not tackle its historical profitability problems.
We expect Iveco's profitability to suffer in 2012 because of lower unit sales caused by weak Southern European demand and falling Brazilian demand after the introduction of new emission regulations that will impact all truck makers. Iveco's profitability is already faltering because of European overcapacity. In light of these expectations, under our base-case scenario we are assuming that Fiat Industrial's revenues might increase about 5% in 2012 and that the reported trading margin could be marginally stronger than the 6.9% reported in 2011. We believe that the group's ability to generate free operating cash flow (FOCF) should continue in 2012. FOCF will probably be lower than in the previous two years, however, because of an increase in the capital spending, but still more than sufficient to cover the EUR230 million dividend payment and acquisition of a 51% stake in Barclays Mercantile Business Finance Ltd. (not rated) when the IFHL Iveco Finance Holding Ltd joint venture ends. At the end of 2011 the funds from operations (FFO)-to-debt ratio was about 20%, in the low end of our 20%-25% target. We do not expect this ratio to improve in 2012 owing to Iveco's earnings weakness, but we are assuming under our base-case scenario that it will not deteriorate and that in 2013 it will improve toward the higher part of the target range. We are not factoring in any acquisitions beyond Barclays, and we are assuming that the dividend payment will stay in the range of a 30%-35% payout ratio, as the group's CEO recently indicated.
The short-term rating is 'B'. We assess Fiat Industrial's liquidity as adequate under our criteria. The coverage ratio of sources to uses in the next 12 months is 1.2x.
On Dec. 31, 2011, Fiat Industrial's main liquidity sources consisted of:
-- About EUR5.6 billion in cash at group level. This included EUR1.4 billion allocated to the financial services division and EUR750 million that we consider tied to operations and that we do not deduct from debt in our coverage ratio calculation.
-- A EUR2 billion revolving credit facility (RCF) maturing in January 2014, of which EUR1.5 billion was undrawn, and another EUR100 million in undrawn committed lines.
This compares with:
-- Near-term cash calls, including short-term debt maturities of EUR3.1 billion. This amount does not include Fiat Industrial's asset-backed securities (ABS).
-- Expected positive FOCF that will be largely absorbed by the payment of dividends of EUR230 million and the EUR119 million acquisition of the Barclays stakeholder in the IFHL joint venture.
We see Fiat Industrial's ability to access diverse sources of funding as crucial for its financial services activities. We understand that the group's financial services business usually requires less cash than the industrial division. We treat the reported cash in the financial services division as restricted cash and we do not deduct it from the financial debt.
The recovery rating on Fiat Industrial's EUR1 billion 5.25% unsecured notes due 2015, EUR1.25 billion 6.25% unsecured notes due 2018, and EUR2 billion revolving credit facility (RCF) is '4', indicating Standard & Poor's expectation of average (30%-50%) recovery in the event of a payment default. This corresponds to an issue rating of 'BB+' in this debt, in line with the corporate credit rating on the group.
The recovery rating is supported by the group's significant asset valuation. At the same time, the recovery rating is constrained at '4' by the group's significant debt outstanding at our simulated point of default, the note's weak documentation compared with the RCF documentation, and Italy's insolvency regime, which we view as a less creditor friendly jurisdiction than others.
To calculate recoveries, Standard & Poor's simulates a hypothetical default scenario, which, in the case of Fiat Industrial, would be caused by a prolonged economic slowdown paired with an inability to raise additional debt in a stressed capital market. We assume that the primary insolvency proceedings would occur in Italy.
We have valued Fiat Industrial based on discrete asset valuation, as we believe this provides a good indication of the value available to creditors. However, we believe the group would reorganize as a going concern because it has, in our view, a strong brand and a viable, cash flow generative business.
In our valuation of Fiat Industrial we have deconsolidated CNH, which is 88.4% owned by Fiat Industrial, from Fiat Industrial's accounts, but we have included some stressed equity value for CNH. This acknowledges the possibility that, at the point of hypothetical default, CNH could still be part of the Fiat Industrial group, although we believe its value would be similarly stressed and that Fiat Industrial could dispose of some of its stake on the path to default. Furthermore, consistent with Standard & Poor's captive finance methodology, and given Fiat Industrial's nonrecourse nature, we have not taken into account any value for its financial subsidiaries.
We have applied haircuts of about 70% to the book values of Fiat Industrial's industrial business, which, together with the stressed equity value of CNH estimated at the EUR800 million point of default, results in a stressed enterprise value of about EUR3.6 billion at our hypothetical point of default in 2016. We have assumed that debt maturing prior to 2016 is refinanced under similar terms, and that all facilities are fully drawn at the point of default.
To calculate recoveries, we deduct priority liabilities of about EUR630 million, comprising enforcement costs and 50% of the present value of net pension liabilities, excluding CNH Global's pensions. This gives us a net stressed enterprise value of about EUR3 billion. From this, we deduct EUR430 million of structurally advantaged financial liabilities, consisting of subsidized loans and structurally senior debt located at operating companies, plus pre-petition interest. This leaves about EUR2.5 billion residual value for the pari passu ranking unsecured debt, which includes the unsecured notes, the unsecured RCF, and other debt borrowed at treasury vehicles. This leads to our expectation of recovery prospects at the higher end of the 30%-50% range for the notes and RCF, and a recovery rating of '4'.
Fiat Industrial is liable for some of carmaker Fiat SpA's debt because of the recent demerger. At our hypothetical point of default in 2016, we assume that the outstanding notes benefitting from this guarantee amount to about EUR1 billion. This guarantee could potentially erode recovery prospects but at this stage we do not think it jeopardizes the current recovery rating if Fiat SpA were to see a significant deterioration in its credit quality, leading to a large default risk.
The stable outlook reflects our belief that Fiat Industrial's 2012 credit metrics should be in line with the low end of our 20%-25% FFO-to-debt and our 3.5x-4x debt-to-EBITDA targets, and our expectation that they will slowly strengthen in coming years.
Under our base-case scenario we assume that, owing to weakness in South European markets, 2012 financial metrics will show little improvement apart from a marginal increase in the group's profitability. We don't assume stable debt, as cash generation will likely be lower than it was in 2011. However, we expect positive trends in profitability and debt reduction to restart as soon as macroeconomic conditions in Southern Europe improve.
A worsening or continuation of the weak economic environment in Southern Europe might lead us to consider revising the outlook on Fiat Industrial to negative or lowering the rating. We might also consider revising the outlook to negative or lowering the rating if CNH's activities failed to balance our expectation of weak performance at Iveco in 2012, or if the sluggish economy in Southern Europe had a prolonged or more severe negative impact.
These factors could erode the group's profitability and push its cash generation into negative territory, increasing debt and pushing the FFO-to-debt ratio well below 20%.
At this stage we do not see an upgrade as a likely scenario.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- Update: Jurisdiction-Specific Adjustments To Recovery And Issue Ratings, June 20, 2008
Fiat Industrial SpA
Senior Unsecured BB+
Recovery Rating 4
Fiat Industrial Finance Europe SA
Senior Unsecured * BB+
Recovery Rating 4
Ratings Affirmed; CreditWatch/Outlook Action
Fiat Industrial SpA
Corporate Credit Rating to BB+/Stable/B from BB+/Negative/B * Guaranteed by Fiat Industrial SpA