Moody’s Investors Service has downgraded the issuer rating of car field supplier Continental AG to Baa2 from Baa1.
Concurrently, Moody’s downgraded the senior unsecured ratings of Continental and their subsidiaries Conti-Gummi Finance BV and Continental Rubber of The us (CRoA). The quick-term Prime-two (P-two) ratings of CRoA were affirmed. The outlook on the ratings is detrimental.
“The rating downgrade to Baa2 ratings demonstrates the even further deterioration in the functioning setting for European automotive elements suppliers, the resulting stress on Continental’s revenue margins and financial metrics, as very well as the firm’s elevated distributions to shareholders”, reported Matthias Heck, a Moody’s VP, senior credit officer and guide analyst for Continental.
“The detrimental outlook is pushed by the existing uncertainty struggling with the car sector for 2020 and beyond. The spreading of Covid-19 across Europe that has led to weaker consumer sentiment could make it difficult for Continental to sustain leverage and cash circulation metrics at amounts demanded for a Baa2.”
Moody’s sector outlook on European automotive elements suppliers, very first published 2 March 2020, stays detrimental.
It expects worldwide mild automobile product sales to decrease by an additional two.five% in 2020, following a decrease of four.6% in 2019. Added challenges relate to a worldwide outbreak of the coronavirus and disruption of financial exercise outside of the very first quarter of 2020.
For the sector, Moody’s expects EBITA margins not to get better from already low 2019 amounts, although environmental regulation, electrification and disruptive technologies (such as autonomous driving and digitalisation) represent added challenges for the sector.
For 2020, Continental expects product sales to attain EUR42.5bn to EUR44.5bn while it expects EBIT margins to erode even further to five.five% to 6.five%.
The erosion will arrive in specific from the rubber group, in which margins will decrease to ten% to 11% (from 12.four% in 2019).
In the automotive group margins will attain all around 3% to four%, following four.four% in 2019. In 2019, Continental initiated an efficiency programme to cut down gross charge by approximately EUR500m from 2023. This will, however, only increase the group’s margins by all around 100 basis points whilst requiring upfront fees of all around EUR1.1bn. This implies that Continental’s EBIT margin will remain below eight% until finally following 2021 and hence placement the enterprise
weakly in the Baa2 rating class.
Far more positively, Continental’s cash generation by means of 2019 remained good, with cost-free cash circulation (FCF) following dividend remaining constructive. For 2020, Continental expects a FCF (prior to M&A and dividend payments) of EUR0.7bn to EUR1.1bn. After management’s proposed dividend payment of EUR800m, this leaves FCF in a variety or minus EUR100m to furthermore EUR300m, a small stage taking into consideration the highly volatile sector setting and the potential of some even further, albeit smaller, M&A transactions. Moody’s considers that Continental’s shareholder distributions have come to be extra intense.
During 2012-2018, dividend payouts elevated gradually from 24% to 33%. Even though this level was continue to balanced and in line with the sector normal, the proposed payment for 2019, albeit to some degree decrease than past calendar year, is for a year with detrimental earnings and elevated personal debt amounts.
At the conclusion of December 2019, Continental’s noted personal debt elevated to EUR7.6bn. On a Moody’s altered basis, which includes pension liabilities, gross personal debt amounted to around EUR12.5bn. This interprets to an altered personal debt/EBITDA of around two.5x. For 2020, the ratings agency expects Continental’s leverage to remain at all around this stage, due to ongoing margin stress and even with some personal debt reduction due to bond maturities.
For 2021, Moody’s expects leverage to boost marginally within a variety of two.-two.5x, which includes and excluding the proposed spin-off of Vitesco Systems.
Continental’s Baa2 very long term issuer rating requires into thought the company’s (a) sturdy business profile as the 3rd biggest Tier 1 global auto supplier with revenues of more than EUR44bn in 2019 (b) diversity across many business regions and product lines (c) major position both in tyres and industrial-struggling with firms which lessens exposure to the initial machines (OE) automotive field (d) significant proportion of revenues from the replacement tyre aftermarket which is less cyclical than for initial machines product sales (e) excellent positioning to mitigate the disruptive developments struggling with the automotive industry and (f) fairly sturdy credit history metrics with leverage (as measured by Moody’s altered personal debt / EBITDA) of two.5x and retained cash
circulation (RCF) / net personal debt of forty two% as of December 2019, and the maintenance of a great liquidity profile.
Yet, the rating demonstrates as detrimental the firm’s: (a) exposure to the cyclicality of the automotive field (b) significant exploration and enhancement (R&D) fees inside the automotive business, albeit equivalent to peers (c) exposure to risky raw material charges and overseas trade fees, (d) credit history challenges relevant to significant shareholder distributions, including cash dividend payments and the proposed spin-off of Vitesco Technologies.
Environmental, social and governance (ESG) challenges are relevant and have been reflected in Continental’s ratings. Some of Continental’s end products, particularly in the region of powertrain (Vitesco Systems), are negatively impacted by stricter environmental regulation of passenger and professional automobiles and the trend in the direction of electrification. This results in decrease demand from customers and revenue margins for present merchandise and requires significant exploration and enhancement charge for new merchandise.
Continental’s governance challenges are reasonable. As a stock market place listed company, it presents great disclosure in conditions of economic and sustainability reporting. The firm’s economic plan incorporates the maintenance of great liquidity. The enterprise has, however, come to be more aggressive in conditions of shareholder distributions. Moody’s therefore considers the economic plan to be extra in line with a Baa2 rating and expects, centered on its public rating concentrate on, that the enterprise would take measures to defend this rating if wanted.
Rationale for detrimental outlook
The detrimental outlook demonstrates (i) challenges relevant to the significant cyclicality of the automotive field, (ii) material quick-term challenges regarding a worldwide outbreak of the coronavirus and its challenges on production, security of source chains and client demand from customers for automobiles, and (iii) ongoing challenges in the automotive field, such as electrification and disruptive technologies, which demand ongoing high amounts of R&D expending and restrict cost-free cash circulation generation. In this environment, it may possibly be difficult for Continental to (i) preserve its debt/EBITDA (Moody’s altered) at a highest of two.5x, which is expected the Baa2 rating, (ii) boost EBITA margins (Moody’s altered) to at least eight% more than the subsequent two-3 years, provided the difficult sector environment and even with efficiency actions.
What could adjust the rating
Moody’s may possibly look at downgrading Continental’s ratings to Baa3 in case of (1) an raise in leverage (personal debt/EBITDA) to over two.5x for a prolonged time period (two.5x as of December 2019) (two) the RCF/net debt coverage ratio falling below thirty% (forty two% as of December 2019) (3) a failure to get better altered EBITA margin to at minimum eight% on a sustainable basis (as of December 2019: seven.four%) or (four) a deterioration in Continental’s liquidity profile.
The ratings could be upgraded if Continental was in a position to (1) demonstrate a sustainable Moody’s-altered cost-free cash circulation generation in extra of EUR1bn per annum, that would be applied to (two) a even further debt reduction major to a decrease in Moody’s leverage (personal debt/EBITDA) of constantly below two.0x (3) attain an EBITA margin (as outlined by Moody’s) sustainably over ten% and (four) an RCF/net personal debt over 45%.