Swedish Bearing Co. SKF Outlook Revised To Positive On Expectations Of Improving Credit #BBB-# Ratings Affirmed

Stocks and Financial Services Press Releases Wednesday February 14, 2018 17:57
STOCKHOLM--14 Feb--S&P Global Ratings

STOCKHOLM (S&P Global Ratings) Feb. 14, 2018--S&P Global Ratings said today that it had revised its outlook on Sweden-based capital goods company SKF AB to positive from stable. At the same time, we affirmed our 'BBB-' long term issuer credit and issue-level ratings on SKF and its senior unsecured debt.

We revised the outlook to positive because we believe SKF will continue making good progress in deleveraging its balance sheet over the near to medium term, supported by the recovery in the auto sector and last year's strong demand in its industrial end markets. Restored operating profit margins from cost-reduction initiatives and positive free operating cash flow (FOCF) generation will also contribute to debt reduction.

Given the underlying cyclical and volatile nature of the bearings industry, we would expect SKF's credit metrics to materially strengthen in the current positive business cycle, better positioning the company to weather an industry downturn. An upgrade would be contingent on our expectations of a material strengthening of cash flow credit metrics in 2018 and 2019, with funds from operations (FFO) to debt well above 30%, with SKF applying a large share of its FOCF toward debt reduction.

SKF's operating and financial performance is buoyed by a strong industry environment, which allows SKF to make positive price adjustments and sell more units. The favorable market environment and expected top line growth is, however, partly tempered by rising raw material costs and foreign currency headwinds. As a result, and combined with ongoing efforts to manage its cost base, the group's profitability has gradually returned to 2014 levels. We forecast SKF's EBITDA margin will remain above 14% in 2018 and 2019, compared with 13.7% in 2016, which will support steady EBITDA growth and improving credit metrics. Furthermore, we expect working capital to continue building, which is normal during periods of increased demand. Despite this, we expect SKF to continue delivering healthy free cash flow of around Swedish krona 5 billion (about US$618 million or EUR504 million) annually. We expect the company to manage dividend payout so it remains flat year on year, which, combined with asset sales and pension-restructuring efforts, we believe indicates SKF's commitment to further deleveraging its balance sheet.

Our view of a softer auto industry (about one-third of SKF's revenues in 2017) could lead to weakened top line growth over the medium term. In 2018 and 2019, for example, we expect auto sales volumes in the key U.S. market to weaken slightly from the strong 2017 levels. Nevertheless, we forecast a relatively healthy annual production rate of 16.5 million-17.0 million units based on our expectation of a steady U.S. GDP (see "Industry Top Trends 2018: Autos," published Nov. 15, 2017, on RatingsDirect), but only slight volume growth in Europe, the Middle East, and Asia.

We expect SKF's business risk profile to continue to benefit from its position as the leading global manufacturer in the cyclical and competitive bearings industry, where we estimate it has about a one-third share of the European market. The company also benefits from broad geographic and customer diversity, good operating performance, and a wide distribution network. SKF's business risk remains constrained, in our view, by its exposure to cyclical and competitive end markets, high fixed costs, periodic demand and supply imbalances, and a strong customer bargaining power that reduced pricing flexibility. This is largely a factor of its exposure to the cyclical and volatile automotive, mining, and construction end markets.

SKF's management has taken some cost-cutting and debt-reduction measures, including divesting noncore businesses such as Reelcraft, and consolidating its manufacturing footprint. This, together with the ability to increase prices on the back of a strong industry environment, should allow SKF to maintain its operating margin above 14%.

The positive outlook reflects the likelihood that we could raise the ratings on SKF within the next 12-24 months if we expect that the company will maintain its operating margins above 14% and FFO to debt near or above 30% over the next 12-24 months, and over a business cycle. In our opinion, however, SKF's future financial risk profile is influenced by how much free cash flow the company chooses to allocate to acquisitions, debt reduction, and shareholder distributions.

We could revise the outlook to stable if the industry environment weakens beyond our current expectations, the company's financial policies become aggressive, or if it makes a large debt-financed acquisition that leads to FFO to debt remaining below 30% for a protracted period.


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