Rating Action: Moody's affirms Timken's Baa3 senior unsecured rating; outlook remains positive
Global Credit Research - 25 Aug 2020
New York, August 25, 2020 -- Moody's Investors Service ("Moody's") affirmed its ratings for The Timken Company ("Timken"), including the company's Baa3 senior unsecured debt rating. The ratings outlook remains positive.
"While Timken has performed well relative to industrial firms to this point in the COVID-related downturn, the ongoing challenges that the pandemic presents will nonetheless slow the company's operating improvement trends," says David Berge, Moody's Senior Vice President and lead analyst for the company. "However, assuming strong if only partial recovery in business conditions in 2021, Timken remains on track towards achieving deleveraging goals that would likely support a higher rating."
The rapid and widening spread of the coronavirus outbreak, the deteriorating global economic outlook, low and volatile oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The industrial goods industry sub-sector has been one of the most significantly affected given its sensitivity to consumer demand and sentiment. Timken's exposure to automotive and truck manufacturing end markets, in particular, render the company vulnerable to shifts in market sentiment and operational disruptions in these unprecedented times, and the company subsequently remains vulnerable to the lingering adverse effects of the outbreak. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.
Timken's ratings are broadly supported by a long-established leadership position in the roller bearings market, upon which the company has been able to gradually grow and diversify its revenue base through a well-managed program of acquisitions. The company's business model focuses on specialized products sold to industrial and transportation related customers that provide the best profit potential, rather than seeking size or overall market leadership. While it remains relatively modest in size compared to other industrial companies, Moody's believes that this approach has strengthened Timken's resilience throughout volatile cycles in industries that it serves, the current COVID-related downturn in particular. This business model allows the company to sustain relatively strong margin and free cash flow generation notwithstanding the short-term weakening in demand. Timken reported EBITA margins in excess of 16% for the first six months of 2020, despite a nearly 13% decline in sales from the same period in 2019. This reflects prompt and effective cost-cutting measures that Timken instituted in response to the pandemic which, along with working capital recapture in the second quarter, contributed to free cash flow generation of $200 million in the first half of 2020, versus normal annual free cash flow of approximately $300 million.
Moody's expects weaker demand conditions to continue through the second half of 2020, especially in the company's Mobile Industries segment, which serves among others automotive and truck manufacturing end markets (combined 21% of 2019 revenue) that have been especially hard-hit by the pandemic (segment revenue declined 18% in the first half of 2020 versus the same period in 2019) and will likely remain weak throughout 2020 before resuming only slow growth. As such, Moody's expects EBITA margins to be in the low teens percentage range in the second half of this year, before gradually resuming to the 15% to 16% range in 2021 and thereafter. Likewise, the weak conditions persisting through the remainder of 2020 are expected to slow cash flow generation, although Moody's believes free cash flow will be close to $300 million for the year. The maintenance of strong cash flow generation, along with cash balances that exceeded $400 million as of 30 June 2020 and the suspension of share repurchase activity for 2020, will be important to allow the company to repay debt through the year. With a modestly reduced debt balance along with likely earnings improvement in 2021, Moody's expects debt-to-EBITDA will fall closer to the 2.5x level by the end of 2021, down from a peak of close to 3x in 2020 and thereby continuing to support the positive ratings outlook.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Timken's ratings could be upgraded if Moody's expects that the company can sustain EBITA margins in the mid-teens range in 2021 and generate strong free cash flow through 2020 and 2021, with debt-to-EBITDA reduced to close to 2.5x by the end of that period. As business conditions improve, Moody's expects that Timken will undertake modestly sized acquisitions, but the ability to sustain margins and cash flows without a material increase in leverage would be important to support a higher rating.
Ratings could be downgraded if Timken meaningfully increases debt levels to fund an accelerated pace of acquisitions or shareholder returns, or if the decline in earnings due to COVID deepens or lingers past 2020, resulting in debt-to-EBITDA that is sustained above 3x. As well, ratings could be downgraded if the company encounters negative or breakeven free cash flows, or if EBITA margins were to approach 10% or EBITA-to-interest falls below 5x.
The Timken Company (NYSE: TKR), headquartered in North Canton, Ohio, is a global manufacturer of bearings and assemblies, power transmission systems, gearboxes and related products and services. Timken operates under two reportable segments: Mobile Industries and Process Industries, both contributing about 50% of sales in 2019. Timken generated approximately $3.5 billion of revenue in last 12 months that ended on 30 June 2020.
The following is a summary of Moody's ratings and today's rating actions:
..Issuer: Timken Company (The)
....Senior Unsecured Shelf, Affirmed (P)Baa3
....Senior Unsecured Regular Bond/Debenture, Affirmed Baa3
..Issuer: Timken Company (The)
....Outlook, Remains Positive
The principal methodology used in these ratings was Manufacturing Methodology published in March 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1206079. 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.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
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David Berge, CFA Senior Vice President Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Russell Solomon Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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