- Given the deep shocks to both the supply and demand sides of the U.S. economy, we estimate that U.S. light vehicle sales will likely decline by 25.0% year over year to 12.7 million units in 2020 before recovering to 15.1 million units in 2021.
- The frequency and depth of our downgrades in 2020-2021 will likely be less severe than the downgrades we undertook in 2008-2009, which reflects that we already lowered our ratings on many companies in the sector in 2018 and 2019 due to industry headwinds related to high investment needs, tariffs, and regulatory compliance costs in the lead up to the coronavirus pandemic.
- Investment-grade issuers will likely tap the financial markets to pay down their revolvers and improve their liquidity to better withstand the high production volatility over the next quarter as supply chain bottlenecks emerge or if there is an extended downturn.
- Speculative-grade auto suppliers, especially those we rate in the low BB/B categories, typically have much less headroom in their cash flow adequacy metrics than their investment-grade competitors and we expect their headroom to weaken further as they build working capital to support the restart of their production facilities.
- About one-fifth of the U.S. auto issuers we cover are rated 'CCC+' or lower, which indicates a high probability of default.
The measures intended to contain the spread of the coronavirus have pushed the global economy into the deepest recession since the Great Depression. Our economists forecast that U.S. GDP will contract by 5.2% in 2020 before rebounding by 6.2% in 2021, which suggests that the drop in economic activity will be sharp but brief, though the timing and trajectory of the recovery remain uncertain. Due to the steep expected decline in U.S. light-vehicle sales in 2020, we have taken a significant number of rating actions on U.S. automotive credits. In addition, there is still no light at the end of the tunnel for many of these issuers because of the possibility for a resurgence in the rate of infection as governments lift the restrictions they put in place to contain the spread of the virus.
The ongoing recession will lead to a severe decline in auto companies' cash flow adequacy metrics in 2020. However, our future rating actions will focus at least as much, or even more, on their performance in 2021-2022. Even with a recovery, we forecast U.S. light-vehicle sales will remain 10%-15% below 2019 levels in 2021. Based on disclosures during an industry conference held on June 10 and June 11, we expect high volatility in the weekly U.S. production schedules for automakers in this environment and considerable strain on the supply chain. Many automaker and supplier plants could operate at sub-optimal capacity and at less-efficient levels for the remainder of 2020. In addition, nearly all issuers will end 2020 with a higher debt load than they began the year with. Therefore, we expect the profitability and cash flow adequacy metrics of companies in this sector to be weaker in 2021 compared with 2019.
Auto issuers with less aggressive financial profiles, as indicated by their lower debt leverage, can typically raise capital even during periods of stress. However, this is not the case for the majority of auto entities in the U.S. where higher-risk, speculative-grade issuers dominated before the current crisis erupted (see chart 1).
In this article, we summarize the rating actions we've taken on U.S. automotive companies since the beginning of the coronavirus pandemic and discuss the key themes in each subsegment and rating category. Given the heavy preponderance of ratings on CreditWatch or with negative outlooks (82% of our rated universe, see chart 2), we also address some of the factors we will focus on over the coming months to resolve these CreditWatch placements and negative outlooks in the last section of this report.
Mixed Rating Trajectories For U.S.-Based Automakers
Four important factors for a U.S.-based automaker to achieve or maintain an investment-grade rating are steady profitability (EBITDA margins of 6%-10%), a conservative balance sheet (evidenced by debt to EBITDA of less than 2x), strong liquidity (including minimum cash thresholds), and a consistent free operating cash flow (FOCF)-to-debt ratio above 15% over multiple periods (with more weight on our forecast periods).
Ford Motor Co. (BB+/Watch Neg)
Over the past couple of years, we indicated in our reports on Ford that we could undertake a multi-notch downgrade and lower our long-term issuer credit rating to the speculative-grade category if a deep U.S. recession coincided with a lack of profitability improvement in its European and Chinese operations, which would reduce its cash cushion to withstand an imminent downturn. Because the company's weak fourth-quarter 2019 results and soft guidance for 2020 (pre-COVID) were only narrowly within our tolerances for an investment-grade rating, we downgraded it to the speculative-grade category in March after the pandemic led to a sudden recession. We believe Ford's EBITDA margin will remain below 6% on a sustained basis and anticipate that it will maintain a FOCF-to-debt ratio of less than 15% under our base-case scenario over the next two years. Our ratings on the company remain on CreditWatch with negative implications.
General Motors Co. (BBB/Watch Neg)
General Motors entered the cycle with stronger profitability and a solid competitive position supported by its consistent operational execution under its current management team and proactive efforts to address its fixed costs globally, including the overcapacity in its North American passenger car segment. Still, our ratings on GM are on CreditWatch with negative implications, which indicates that we could lower our ratings by one notch if it appears likely that the company's FOCF-to-debt ratio will drop below 15% on a sustained basis (beyond 2020) without signs of an imminent improvement.
For both Ford and GM, their debt issuances in recent months and the draws on their corporate credit facilities should provide them with adequate liquidity to navigate the downturn in light-vehicle demand stemming from the government restrictions to contain the spread of the coronavirus and the ongoing uncertainty around when U.S. light vehicle sales will begin to normalize toward 16 million (unlikely before 2023).
Tesla Inc. (B-/Positive)
Our positive outlook on Tesla reflects the increased likelihood that its credit metrics will improve by a greater level than we assume in our base-case scenario because of higher demand and manufacturing-related efficiencies. Given Tesla's capital market transaction in the first quarter of 2020 and its better-than-expected results, we believe that the company continues to have solid financial flexibility to fund its future expansion plans and address its maturing convertible debt. We could take a positive rating action on the company if it reports steady or improving demand for its new products, manages its production bottlenecks and expands its overseas production capabilities, avoids material operational missteps, and we expect its FOCF generation to be at least break even.
Downgrade Risks For Auto Suppliers Remain High
The sudden and significant decline in global auto production has led auto suppliers to report weaker operating results than we previously expected, which will cause their credit metrics to deteriorate. Although the production stoppage-related losses should decline as plants re-open, we expect that their FOCF will remain under pressure over the next 12 months due to suboptimal demand and the buildup of their working capital as production resumes.
We rate more than 35% of auto suppliers 'BB' and above (see chart 3) and these issuers are unlikely to face multi-notch downgrades because they tend to have strong competitive positions in the fastest-growing parts of the automotive industry (such as advanced active safety, electrification, and connectivity), somewhat flexible cost structures, and low-cost production. In addition, nearly all of these issuers have already secured funding to help them navigate the next 12-18 months.
Speculative-grade auto suppliers, especially those we rate in the low BB/B categories, have experienced a faster decline in their ratings during this downturn. For example, we have lowered our ratings on issuers like American Axle & Manufacturing Holdings Inc., Cooper-Standard Holdings Inc., The Goodyear Tire & Rubber Co., and Visteon Corp. due to weaker cash flow metrics and some combination of poor operating performance over the last year, heavy customer concentrations, limited bargaining power, or high debt and related interest costs. Many issuers we rate in the low 'BB' and 'B' categories will look to shore up their liquidity by tapping the financial markets over the coming months. For many auto suppliers, bolstering their liquidity will be critical as they build working capital to support the restart of their production facilities.
Limited Fallen Angel Risk In Autos For Now
Although we downgraded Ford to speculative grade, we see the risk of Lear Corp. and AutoNation Inc. joining the ranks of fallen angels as only modest. Both of these issuers have much greater cushions in their credit metrics relative to Ford's prior cushion at the investment-grade level and have also demonstrated improved operational resiliency in recent years. However, our negative outlook on both issuers still reflects the uncertainty related to the pandemic and the risk of a lower-than-expected recovery in their volumes and profitability in 2021. For both issuers, we could lower our ratings if their FOCF-to-debt ratios fell below 15% or their debt to EBITDA exceeded 3.0x on a sustained basis. For Lear, which will likely face more cyclical pressure as an auto supplier, we could also lower our ratings if its EBITDA margins remain below 8% over the next 12-24 months, which would demonstrate that the company's business lacked the resiliency to withstand a substantial downturn.
|U.S. Auto Issuers On The Cusp Of Becoming Fallen Angels|
|Current rating||Current outlook||Previous rating||Previous outlook|
|Note: Ratings are as of June 1, 2020. Source: S&P Global Ratings.|
More Distressed Exchanges Are Likely As Default Risk Rises
We rate over a third of U.S. auto issuers 'B-' or below (17 companies, see charts 1 and 3). Furthermore, we rate 20% of auto companies 'CCC+' or below, which indicates a high risk for default. For instance, we downgraded SK HoldCo LLC, K&N Parent Inc., USF Holdings, GC EOS Buyer Inc, and certain other auto issuers to 'CCC+' or below due to their unsustainable financial commitments following a liquidity crisis as well as their imminent refinancing risk amid the tough market conditions for niche sponsor-owned suppliers with highly leveraged balance sheets. We also downgraded U.S.-based distributor and supplier of aftermarket brake and chassis components APC Automotive Technologies Intermediate Holdings LLC to 'D' following its Chapter 11 proceedings and ongoing debt restructuring.
Auto Retailers Face Limited Downside Risks As Long As The Volume Of Miles Driven Rises
We have affirmed our ratings on all seven of our publicly rated auto retailers to reflect their resilient business model given that parts and services (P&S) account for about 35%-50% of their gross profit, which acts as a stabilizing force that is especially helpful during a typical downturn. We have revised our outlooks on these companies to negative to reflect the magnitude of the decline in dealership traffic, the potential risk of a drop in the volume of miles travelled, and their lower P&S revenue compared with our base-case assumptions. However, these companies have flexible cost structures and solid management, which will help partially offset the adverse effects of the ongoing recessionary conditions.
A Brief History Of Auto Ratings
From The Great Recession To COVID-19
In general, we do not expect this downturn to create the same level of industry havoc that ensued during the Great Recession (2008-2009) when the auto industry last faced plummeting demand. Notably, compared with the Great Recession, there is a relative lack of government involvement through bailouts, loans (apart from the U.S. Federal Reserve's fallen angel facility), and scrappage schemes this time. Additionally, our current estimate for auto sales of 12.5 million-13.0 million vehicles would represent a 24% increase relative to the level in 2009. Automakers were somewhat profitable at that level in 2011 and 2012 even though it tested their discipline regarding the use of incentives to boost demand. Furthermore, the pace of the sales recovery in our base-case scenario for 2021 and 2022 is higher than the annual growth rates reported between 2010 and 2012.
Generally, auto suppliers are now better able to recover their commodity costs (which make up a substantial 40%-75% of their cost of goods sold) than before the previous downturn through more favorable contract negotiations (a greater use of pass-through agreements and commodity price indexing), which dampens the effect of price swings. Because of their earlier cost cutting and generally better liquidity, we think most auto suppliers will likely survive with limited risk for a multi-notch downgrade as long as their production volumes recover by 15%-20% in 2021.
During the cyclical downturn of 2006-2009, light-vehicle sales in the U.S. fell by almost 44%. Thereafter, sales continued to grow at a brisk pace for seven consecutive years until 2016 when the pace of growth slowed markedly as the industry approached peak levels.
|Rating Activity For Selected Periods|
|Sales peak||Post-full recovery||Pre-recession|
|Actions since December 2016||Actions since September 2012||Actions since June 2007|
As shown in Table 2, there has been a pronounced negative rating bias in this segment in recent years as 94% of our rating actions since 2016 (when auto sales approached their historical peak) have either entailed no change in the rating or a downgrade. We rate almost half of the issuers at a lower level than we did in September 2012, which is when industry sales recovered to their pre-2008 recession pace or replacement/scrappage rate of 12.5 million units.
Nevertheless, for the companies we covered during the Great Recession, our ratings on over half are at least the same or higher today as they were back in June 2007. This is because Ford and GM have strengthened their competitive positions since the Great Recession by improving the quality, fuel economy, safety, and technology of their vehicles. In addition, both have reduced their fixed costs (we estimate that their breakeven sales level is about 11 million-12 million units in the U.S.) and improved their ability to cope with cyclical downturns given their stronger liquidity positions. Furthermore, auto suppliers, like Harman International Industries Inc., Aptiv PLC, Lear Corp., Sensata Technologies B.V., and Stoneridge Inc., have benefitted from various restructuring actions, such as fewer but more-focused business segments, increased customer diversity, the transfer of manufacturing capacity to lower-cost regions, vertical integration, and elevated manufacturing efficiencies. They have also positioned their portfolios to capitalize on some of the fastest-growing areas of the automotive industry, such as advanced active safety, electrification, stringent emission standards, and connectivity. Lastly, our ratings on most auto retailers also remain higher than they were in 2007 due to the proven resiliency of their business model under which the recurring nature of their P&S sales and elevated penetration of financing and insurance sales with higher margins help dampen the adverse effects of industry downturns.
Key Credit Considerations For Upcoming Rating Actions
- Liquidity: As issuers across categories (automakers, suppliers, and dealers) look to shore up their liquidity by tapping the financial markets, this could lead to more affirmations, which occurred with Aptiv PLC. In the coming weeks, a few more of the issuers we took rating actions on in recent months (see table 3) could look to extend their debt maturities and reduce their refinancing risk. For many suppliers it is critical for the next stage because they will look to build working capital to support the restart of their production sometime over the next few weeks.
- Leverage and financial policy: For the companies that have avoided a near-term cliff event, we will focus on their stated leverage target and ability and willingness to reach it. For instance, in the case of Aptiv PLC, we believe its recent capital raise should help it maintain its competitive edge when markets stabilize because the company will have reserves ready to acquire new technology and diversify its mix outside the light-vehicle market.
- Management: We will also increasingly focus on qualitative aspects related to how management teams look to tackle this next phase. Namely how they balance their commitment to their long-term product cycle plans with the need to prioritize higher-margin programs and proactively manage their associated supply chains to avoid bottlenecks, especially related to Mexican production and some supply chain reconfiguration. We will also monitor their execution on key product launches. We are already seeing launch delays of about 4-5 months, which is critical because of the implications for the companies' EBITDA margins as most participants make a lot more money on newer vehicles than older models. Furthermore, we will focus on the management of their cost structures and efficiency and payback of their restructuring actions. Specifically, we will look to distinguish the management teams that take proactive steps, including implementing capacity cuts and pushing for consolidation. We assume U.S. utilization will be in the mid-60% area in 2020 and do not expect it to reach the 75%-80% range under our base case until 2023.
- Demand: The extent of the demand recovery into 2021 is a critical assumption. Automakers have to maintain their transaction prices but will also face reduced consumer confidence due to the ongoing recession. Consumers' willingness to spend on big-ticket items could also depend on the availability of further stimulus or the implementation of scrappage schemes, such as a renewed cash-for-clunkers program.
- Q&A: COVID-19 And The Auto Industry--What’s Next?, June 9, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Nishit K Madlani, New York (1) 212-438-4070;|
|Secondary Contacts:||Lawrence Orlowski, CFA, New York (1) 212-438-7800;|
|David Binns, CFA, New York (1) 212-438-3604;|
|Alexandra Dima, CFA, Toronto + 1 (416) 507 3227;|
|Nick Santoro, New York + 1 (212) 438 1201;|
|Research Assistants:||Sandeep Mantri, Mumbai|
|Suraj Rajani, Mumbai|
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