Moody’s lifts Continental AG rating to Baa1

Moody’s Investors Service has upgraded its rating for tyre and automotive systems manufacturer Continental AG, and removed the restriction that the company’s rating must remain within three notches above that given to major shareholder Schaeffler AG. This upgrade applies to both the long-term Issuer Rating and the senior unsecured ratings of Continental and its rated subsidiaries, and sees it rise from Baa3 to Baa1.

According to Oliver Giani, Moody’s lead analyst for the European automotive supplier sector, the decision to upgrade Continental’s rating was “the result of a reassessment of our approach in reflecting potential for excessive shareholder distributions undertaken by Schaeffler on the back of its 46 per cent shareholding in Continental.” Giani notes that Continental has “now built a track record of adhering to a balanced financial policy,” and this has led to strong improvements in the company’s standalone credit quality. “Therefore, we no longer consider the previous rating limitation for Continental of three-notches versus Schaeffler AG (Ba3 stable) to be warranted.”

Obligations rated ‘Baa’ are judged by Moody’s to be medium-grade and subject to moderate credit risk, and as such may possess certain speculative characteristics. Moody’s states that the outlook on its rating for Continental is “stable” and it views the company’s liquidity position to be “solid”, with liquidity sources “comfortably covering” committed cash outflows over the next 12 months.

Ratings rationale

Moody’s writes that the Baa1 rating assigned to Continental acknowledges the company’s “strong business profile” over a broad range of automotive industry products: It notes that Continental’s Rubber business, which accounted for 39 per cent of 2014 turnover and 55 per cent of reported EBITDA, provides for “fairly stable and high profitability and positive cash flows through the cycle,” while its Automotive “business benefits from strong market positions and high technological content, resulting in above average margins and high barriers to entry.” One area to keep an eye on, however, is Continental’s powertrain segment (part of the Automotive group and accounting for 19 per cent of group sales), which reported a weaker performance in 2014 due to €285.1 million negative special effects; Moody’s opines that there is “some uncertainty” regarding the potential and pace of a turnaround.

“Supported by an organic sales growth of 4.2 per cent in 2014, Continental continues to show solid profitability and a strong free cash flow generation. The company exhibits strong credit metrics, such as debt/EBITDA of 1.9x with an EBITA margin of 11.4 per cent (2014),” writes Moody’s.

At the same time, Moody’s notes that the Baa1 rating is still constrained by some “overhang resulting from uncertainty” regarding the financial policy of its major shareholder, Schaeffler AG (Ba3 stable), which has a high level of indebtedness, driven by its initial investment in Continental. “However, taking into consideration Schaeffler’s gradual reduction in its shareholding in Continental over the past six years, from 89 per cent in 2009 to 46 per cent at present, and the track record of a balanced financial policy, Moody’s has assumed that such a transaction is increasingly unlikely.” Moreover, significant improvements in Continental’s profitability and capital structure during the past four years provide some cushion in the Baa1 rating category, even in an unlikely scenario of rising shareholder distributions. “Moody’s therefore has lifted the restriction limiting Continental’s rating to be up to three notches above the rating that is assigned to Schaeffler. The still remaining overhang is factored into the Baa1 rating assigned.”

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