CHICAGO--Fitch Ratings has upgraded the Long-Term Issuer Default Rating (IDR) of Snap-on Inc. (Snap-on) to 'A' from 'A-', and Short-Term IDR to 'F1' from 'F2'. The Rating Outlook is Stable. Snap-on had $896 million of debt outstanding as of Oct. 1, 2016. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The upgrade reflects the improvement in Snap-on's operating and credit metrics over the past several years and Fitch's expectation that these trends will continue. Snap-on is generating healthy top-line growth driven by solid growth at its Snap-on Tools and Repair Systems and Information (RS&I) Groups, offsetting moderate declines in its Commercial & Industrial (C&I) Group. Fitch expects that these groups, collectively Snap-on's manufacturing operations, will maintain a mid-single-digit top-line growth rate over the medium term.
The Snap-on Tools and RS&I Groups together address the auto repair market and accounted for around 69% of Snap-on's sales in the LTM period ended Oct. 1, 2016. These groups have grown at a healthy mid- to high-single-digit rate since the 2009 recession, with additional growth upside as vehicles continue to age and become more technically complex. The C&I Group (23% of LTM sales) addresses industries outside the automotive repair segment including the aerospace, military, oil and gas, natural resources and power generation industries. These operations have generated uneven growth in recent years reflecting challenging end-market conditions.
EBIT margins at Snap-on's manufacturing operations improved to 18.9% in the first nine months of 2016 from 17.3% in the first nine months of 2015, reflecting the effect of sales volume leverage and savings from continuous improvement initiatives. Fitch believes there is additional upside to the manufacturing operating margin over the medium term due to continued healthy volume growth and ongoing cost savings efforts.
Snap-on provides customer financing through Snap-on Credit (SOC), which had receivables of approximately $1.8 billion as of Oct. 1, 2016. This business provides strategic advantages to Snap-on in terms of attracting and retaining customers by structuring flexible payment terms. The company employs consistent underwriting standards and prudent risk management, and asset quality metrics are considered strong relative to the portfolio's subprime orientation, supported by weekly, in-person collections by the franchisees. At Oct. 1, 2016, 30-day delinquencies were 2% of total receivables.
All of Snap-on's long-term debt is at the parent level and is allocated internally to SOC. Under Fitch's criteria for rating non-financial corporates, a baseline debt/equity ratio for a captive finance company's operations was determined based on our assessment of the company's asset quality, liquidity and funding profile. In Snap-on's case, Fitch believes a leverage ratio of 4x or less is supportive of SOC's activities on a stand-alone basis at a low investment grade level. Snap-on targets leverage at SOC at a debt/equity ratio of 5x, though it is currently below this level, at under 4x.
Leverage at SOC has improved as receivables have grown from $1.1 billion in 2012 to around $1.8 billion currently while debt levels declined over the same period. Fitch expects the company will maintain financial services leverage at current levels or modestly higher over the near- to intermediate-term, as receivables growth will likely be funded primarily with operating cash flow and debt levels will be relatively steady. Leverage in excess of 4x at the SOC level would be included in Fitch's leverage calculation at the manufacturing operations to reflect the additional risk associated with a more highly leveraged finance operation.
Fitch views the credit business as moderately more risky than the manufacturing operations. As such, an extended period of growth of the receivables portfolio in excess of the growth of the manufacturing operations, causing the credit business to represent a materially larger proportion of consolidated assets and earnings, could be a rating concern.
Leverage at the manufacturing operations (with SOC on an equity basis) as measured by debt/EBITDA is immaterial, and Fitch expects manufacturing leverage will remain at low levels as its capital requirements are being funded with internally generated cash flow. On a consolidated basis, including the finance operations, leverage was 1x as of Oct. 1, 2016, in-line with year-end 2015. We expect consolidated leverage will remain at or near 1x going forward absent a sizable acquisition.
FCF after dividends for the consolidated entity has ranged from $200 million to $300 million annually over the past three years, and is expected to continue in this range reflecting strong operating margins and relatively modest capital requirements (capex/revenues of 2%-2.5%). Fitch expects FCF will be used to fund growth in the receivables portfolio at SOC. In addition, cash flow will be used for acquisition opportunities, funding pension liabilities, and increasing dividend payments. Fitch also expects management will continue to make moderate share repurchases, primarily to offset option dilution.
Snap-on recently announced the acquisition of Car-O-Liner, a Sweden-based maker of collision repair equipment and information and truck alignment systems, for $155 million. This acquisition, which is expected to be financed with a combination of cash and commercial paper, is Snap-on's largest acquisition in several years, though it is a manageable size and of the "bolt on" variety. Fitch expects Snap-on will continue to look for bolt-on acquisitions that would allow the company to expand into emerging markets, critical industries, and enhance its capabilities in serving vehicle repair facilities.
Snap-on's ratings are supported by its strong operational performance, high level of customer brand loyalty, conservative financial management and consistent FCF generation. Key concerns include risks associated with the financial services business, such as the potential need for additional financial support from the parent company, the company's dependence on the auto repair market, and soft results from the commercial and industrial (non-automotive) business.
Fitch's key assumptions within our rating case for Snap-on's manufacturing operations include:
--Revenues grow at 2.5% in 2016, 6.0% in 2017, taking into account the acquisition of Car-O-Liner, and 4.0% annually thereafter.
--EBIT margins expand by around 90bps in 2016 and grow at a slowing rate thereafter.
--Debt/EBITDA at the manufacturing operations remains nominal, and adjusted debt/EBITDAR remains at around 0.3x.
--Finance operation debt/equity remains at 4.0x or less with a consistent risk appetite and funding profile
Factors that could lead to a negative rating action include deterioration in market fundamentals resulting in a sustained reduction in sales and cash flow, or a large acquisition, leading to an increase in leverage (debt/EBITDA and FFO adjusted leverage) at the manufacturing operations to above 1x for an extended period.
A negative rating action for Snap-on could also be influenced by developments at SOC. For example, a negative action would be considered if the financial services operation experiences a substantial deterioration in asset quality and higher leverage levels that require meaningful support from the manufacturing operations. In addition, if SOC's successful execution results in the credit business representing a materially larger proportion of consolidated assets and earnings, this could contribute to negative rating action.
An upgrade is not expected over the medium term given the risks related to the credit business, the focus on the auto repair sector, and the moderate level of cyclicality inherent in the business.
Snap-on maintains solid liquidity including an undrawn $700 million revolver that may be used to back commercial paper borrowings. Nearly all of the company's $117.5 million total reported cash is held at the manufacturing operation with a small amount held at the finance segment. Currently $102 million of reported cash is held overseas with no near-term expectation of repatriation, leaving around $15 million as readily available.
FULL LIST OF RATING ACTIONS
Fitch has upgraded the following ratings for Snap-on:
--Long-Term IDR to 'A' from 'A-';
--Senior unsecured debt to 'A' from 'A-';
--Unsecured revolving credit facility to 'A' from 'A-';
--Short-term IDR to 'F1' from 'F2';
--Commercial paper to 'F1' from 'F2'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Nov. 9, 2016
Summary of Financial Statement Adjustments - Fitch's analysis takes into account Snap-on's results on a consolidated basis and the results for its manufacturing and credit operations on a stand-alone basis. Fitch has made no material adjustments that are not disclosed within the company's public filings.
Additional information is available on www.fitchratings.com.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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