Rating Action: Moody's downgrades Garrett Motion to B2; under review for further downgrade
Global Credit Research - 02 Sep 2020
Frankfurt am Main, September 02, 2020 -- Moody's Investors Service, ("Moody's") has today downgraded the long term corporate family rating (CFR) of Garrett Motion Inc. (Garrett or the company) to B2 from B1 and the probability of default rating (PDR) to B2-PD from B1-PD. Concurrently, Moody's has downgraded to B2 from B1 the senior secured bank credit facilities ratings of the company's subsidiaries Garrett LX III SARL, and Garrett Motion Sarl. Moody's has also downgraded the senior unsecured rating of Garrett LX I SARL to Caa1 from B3. All ratings are placed on review for downgrade. The outlook on all entities has been changed to ratings under review from negative.
"The downgrades reflect Garrett's announcement to explore alternatives for balance sheet restructuring which in our view signals a more aggressive stance to managing its liabilities which may be at the detriment of noteholders." said Matthias Heck, a Moody's Vice President -- Senior Credit Officer and Lead Analyst for Garrett. "The review is focused on the outcome of the company's exploration, which could result in a further downgrade." added Mr. Heck.
Moody's considers the group's more aggressive financial policy as a part of its governance assessment and a key driver of today's rating action.
On 26 August 2020, Garrett announced that it is exploring alternatives to address its balance sheet concerns. The company considers its leveraged capital structure as a significant challenge to its strategic and financial flexibility and to its position in the highly competitive automotive parts supply market. In addition to its high leverage, Garrett also mentions the significant claims related to the subordinated asbestos indemnity and the tax matters agreement, which are generally deferred until the second quarter of 2023 but will impede Garrett's access to capital and its ability to execute its strategy. The company considers its liquidity as ample, given $482 million of cash and undrawn revolver as of June 30, 2020, and mentioned the strength of its core business. The company has not determined whether to pursue any balance sheet restructuring alternatives but mentioned the issuance of equity and a conversion of liabilities into equity as some of the potential alternatives.
Whilst the company's announcement does not include any material new information in terms of current trading and liquidity, it puts a spotlight on the group's medium-term challenges, especially after the covenant relief period from the third quarter of 2023, when indemnity payments are expected to restart again. Moody's considers the company's ambition to de-lever its balance sheet as generally positive. The wide range of alternatives, however, create material uncertainties. Considering the material drop of approximately 60% in Garrett's share price following the announcement (to $2.755 as of 31 August from $6.84 as of 25 August), leading to a current market capitalization of approximately $200 million (as of 31 August 2020) will, however, constrain the company's options with regards to a credit-positive cash injection via a rights issuance. The company has not further specified the options it is considering.
The rating downgrade reflects the increased uncertainty raised by the announcement vis-a-vis the company's stakeholders, and Moody's considers the CFR to be better positioned at B2. The review for downgrade will focus on the option to be determined by the company and its impact on Garrett's credit quality. Moody's continues to consider Garrett's liquidity as adequate. However, as the possibility of a debt-equity swap would likely represent a distressed exchange under Moody's criteria, a further downgrade is highly likely if such option would be selected.
Moody's considers Garrett's liquidity profile as adequate, although it will materially weaken over the next couple of quarters, given the significant expected decline in revenue and EBITDA, leading to downside pressure on cash flow. Nevertheless, cash on balance sheet amounted to $139 million end of June 2020, supported by a $347 million availability under its E430 million revolving credit facility. With the relief until 2Q 2022, Moody's expects Garrett to have sufficient headroom to the new covenant levels. The company does not have short-term debt maturities, so the total liquidity available of $482 million as of June 2020 should be sufficient to mitigate short-term negative free cash flows in 2020, before returning to positive free cash flows from 2021 on.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Further negative pressure would build if Garrett Motion Inc. pursued a balance sheet restructuring option, which would lead to a loss for creditors. A rating downgrade could also emerge if the company fails to return to meaningful operating profit generation of the second half of 2020, thus sustaining adjusted debt/EBITDA above 5.5x and an adjusted EBITA margin trending below 4%. Furthermore, a deterioration in Garrett's liquidity profile would also excerpt negative ratings pressure.
Given the current market situation and the uncertainty about the measures to restructure the balance sheet, we do not anticipate any short term positive rating pressure for Garrett. A successful de-leveraging without losses for creditors, and a stabilization of the market situation leading to a recovery towards metrics to pre-outbreak levels could lead to positive rating pressure. More specifically adjusted Debt/EBITDA would have to drop back sustainably below 4.5x with an EBITA margin sustainably above 7%.
The principal methodology used in these ratings was Automotive Supplier Methodology published in January 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1170606. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Matthias Heck, CFA VP - Senior Credit Officer Corporate Finance Group Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Anke Rindermann Associate Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
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