Moody’s upgrades Michelin
Moody’s Investor Service has upgraded Compagnie Générale des Etablissements Michelin's long-term credit rating to Baa1 from Baa2, with a stable outlook. Michelin’s P-2 short-term rating remains unchanged.
The rationale behind Moody’s upgrade was explained in a 24 April press release: “The upgrade reflects Michelin’s continuous improvement in its financial metrics over the last several quarters – including a capital increase in 2010 – to levels that solidly position the company in the Baa1 rating category as well as Moody’s confidence that Michelin will be able to sustain these metrics over the next years despite economic weakness in major European countries and rising raw materials.”
Moody’s notes that Michelin has grown its adjusted EBIT margin from 5.3 per cent in 2009 to 10.9 per cent in 2010 and 2011, an occurrence it attributes to several factors: the company’s lower cost base following the initiation of restructuring in 2009, growing industry volumes and Michelin’s continued ability to offset raw material cost increases by price rises. Furthermore, the tyre maker’s improved operating performance and a capital injection of 1.2 billion euros in 2010 is credited with a reduction in Michelin’s adjusted leverage to 2.2x Debt/ EBITDA in 2011 from 2.3x in 2010 and 3.9x in 2009. “This highlights the group’s progress in realising cost savings, recovering industry volumes as well as a positive price/mix effect,” said Moody’s.
Expectation of maintained profit margins
The stable outlook reflects Moody’s expectation that Michelin will be able to protect its profit margins achieved in 2011 at above nine per cent; maintain its leverage ratio (Debt/EBITDA) at around 2.2x, the level achieved in 2011, despite a strong increase in dividend payment in 2012; and generate a positive free cash flow before dividend payments. Moody’s stable outlook is also conditional on the group preserving a conservative financial policy and healthy liquidity profile consistent with a high Baa-rated company.
For the current year, Moody’s anticipates declining tyre sales volumes in Europe (where Michelin generated 43 per cent of sales in 2011). However, in North America (33 per cent of revenues) and emerging markets (24 per cent of revenues) demand growth should remain intact, albeit at a lower pace than in 2011. “Overall, we expect a stable tyre sales volume for Michelin in 2012 compared with 2011 volumes,” Moody’s reported. “At the same time we take comfort that Michelin might be able to realise some windfall gains in 2012 from the time lagging effect of price increases implemented in 2011 that will only unfold their full impact in 2012, and that Michelin will be able to sustain its strong pricing power which is crucial to preserve its healthy profit margins going forward.”
Michelin’s Baa1 rating continues to be supported by the company’s strong competitive position, reflecting Michelin’s scale, the strength of its brand name and its position as one of the three leading global tyre manufacturers. Approximately 80 per cent of the company’s revenues are driven by replacement tyre demand, which Moody’s notes is strongly related to GDP growth but tends to be less cyclical than original equipment demand and allows for pricing flexibility. Consequently, Michelin has been able to generate consistently higher profit margins than many other automotive suppliers and manufacturers.
However, Moody’s cautions that Michelin’s rating remains constrained by its exposure to the volatility of raw material prices, notably for natural rubber, synthetic rubber and oil derivatives, which are at historic high levels. Michelin’s ability to implement positive pricing actions – price increases by another name – is viewed by Moody’s as “critical for offsetting higher raw material costs and preserving healthy profit margins going forward.” In addition, the Moody’s rating considers Michelin’s challenge to generate positive free cash flows (after dividend payments) despite rising investments needs for expanding its global footprint and defending its technological advantage, which represents a key hurdle to further rating migration.
Are further up/downgrades foreseen?
Moody’s confirms that a further upgrade of Michelin’s rating is “rather unlikely” over the short to medium term. However, it would consider upgrading Michelin’s Baa1 long-term ratings should the tyre maker demonstrate it can sustainably generate material positive free cash flows and further improve its key financial metrics to constantly generate a RCF/ net debt above 40 per cent as well as a reduction of Debt/EBITDA close to 1.5x.
Pressure to downgrade Michelin’s rating could arise should the company’s credit metrics weaken below current levels, which would be evidenced by a leverage ratio (Debt/EBITDA) approaching 2.5x; a failure to generate positive free cash flow on a sustainable basis; or RCF/net debt ratios falling below 30 per cent.