Fitch Affirms Sanmina-SCI's IDR at 'B+'; Revises Outlook to Stable
Fitch Ratings has taken the following rating actions for Sanmina-SCI Corporation (Sanmina) (NASDAQ: SANM): --Issuer Default Rating (IDR) affirmed at 'B+'; --Senior secured credit facility affirmed ...
Fitch Ratings has taken the following rating actions for Sanmina-SCI Corporation (Sanmina) (NASDAQ: SANM):
--Issuer Default Rating (IDR) affirmed at 'B+';
--Senior secured credit facility affirmed at 'BB+/RR1';
--Senior unsecured notes downgraded to 'BB-/RR3' from 'BB/RR2'.
Fitch has revised the Rating Outlook to Stable from Positive.
Approximately $1 billion of debt is affected by Fitch's action.
The Outlook revision reflects recent revenue declines associated with customer order pushouts and general end-market softness which have delayed any potential margin expansion. As a highly vertically integrated EMS company, Sanmina relies on revenue growth, particularly in its components businesses, to fuel margin expansion. However, 3% revenue declines in the LTM period have resulted in negative operating leverage, with EBITDA margins declining from 5.3% to 4.5% year over year in the March quarter.
Fitch assigned a Positive Outlook to Sanmina in August 2011 with the potential for an upgrade predicated on several factors including: consistent organic revenue growth reflecting the success of management's strategy and execution; sustained EBITDA margin improvement above 5%; consistent free cash flow generation; and continued debt reduction.
Sanmina has redeemed a net amount of $250 million in debt over the past year. Fitch views the debt reduction favorably, as well as the smaller portion of long-term debt relative to the total capital structure which allows for increased financial flexibility. However, positive rating action is predicated on sustainable improvements in financial metrics which appear difficult in the current environment given negative organic growth and the operating leverage inherent in the business model.
The ratings and Stable Outlook reflect the following considerations:
--Fitch believes leading EMS providers, such as Sanmina, are strategic to the business operations and strategy of their customers given their role in product design consultation, component sourcing, manufacturing, fulfillment logistics, and repair/reverse logistics. However, Fitch believes Sanmina may be competitively disadvantaged in rapidly growing areas like the industrial, medical, and clean tech space against larger EMS competitors with greater scale and financial resources, particularly if OEM's seek high credit quality partners for products with longer life-cycles.
--Historically Sanmina has demonstrated strength in the complex, high-mix manufacturing operations. While operating on a smaller scale than other major EMS companies, Sanmina's highly vertically integrated capabilities may allow it to excel in certain niche markets.
--The downgrade of the senior unsecured notes by one notch reflects the reduced recovery prospects as a result of the increase in senior secured credit facilities by $115 million, leaving a smaller portion of cash in a liquidation scenario for the unsecured notes.
Rating strengths include:
--Fitch's belief that the Sanmina's exposure to non-traditional, low volume, high mix segments and expertise in the components space may enable the company to excel in niche markets and offset revenue volatility in highly cyclical markets such as communications and enterprise computing.
Ratings concerns include:
--An intensely competitive environment which pressures profitability across the industry;
--Management's history of underperformance at various times over the past five years in managing a global manufacturing operation in an industry with minimal room for execution missteps;
--A high degree of vertically integrated operations (components represent 20% of revenue) which, while typically a driver of higher margins in growth periods, presents additional challenges for management execution and higher fixed costs;
--Sanmina's significantly smaller size than leading tier-one service providers in a market where scale is of significant importance;
--Modest segment concentration with roughly 46% of revenue coming from the highly cyclical networking and communications segment;
--A highly working capital intensive business that may be a drain on liquidity in periods of growth, although it tends to provide some measure of liquidity during business downturns.
--Customer concentration risk with Sanmina's top 10 customers representing roughly 50% of revenue.
The ratings reflect the following financial expectations:
--Sanmina's revenue declined 3% in the LTM period, due to slowness in all segments except enterprise computing and storage. Fitch expects revenue declines in the high-single digits in fiscal 2012 (ending September) given continued market softness as indicated by management (guidance for -12% revenue declines in Q3). Fitch would expect a Sanmina to be able to produce mid-single digit revenue growth in the current market conditions, similar to peer EMS companies which grew 4% in the LTM.
--Fitch believes EBITDA margins will remain in the 4.5% range in fiscal 2012 with any potential increases thereafter coming from revenue growth and the associated operating leverage. Increased activity in the higher margin industrial, defense and medical segment would further drive any potential upside. However, confidence in profitability improvements is tempered by a history of below-average margin levels and significant industry price competition.
--Fitch estimates current leverage (total debt to total operating EBITDA) at roughly 3.2x. Fitch expects leverage to remain above 3.0x in the near to medium term; however, further debt reduction resulting in leverage materially below 3.0x would be positive for the credit. LTM interest coverage (EBITDA to total interest expense) is expected to increase from 3.2x a year ago to 4.0x at fiscal year end 2012 due in part debt reductions. Funds from operations less capital spending and dividends are expected to equal roughly 35% of total debt at the end of fiscal 2012.
--Fitch expects Sanmina to be free cash flow positive in 2012 given neutral working capital cash flows as well as reduced interest expenses. Cash flow is expected to be roughly $100 million annually going forward given moderate revenue growth.
--Uses of cash flow and excess cash will principally go to fund organic growth, working capital needs, and acquisitions. The company's next debt maturity is not until 2014 when $257 million of senior secured floating rate notes are due. The potential for acquisitions remains although Fitch does not expect any substantial acquisition activity that would result in a material leverage event.
As of March 31, 2012, liquidity was solid with $464 million in cash, $263 million available under an upsized $300 million senior secured asset backed lending facility expiring the earlier of 2014 or 2019 depending on outstanding balances of related debt series, and $105 million of availability from short-term Asian borrowing facilities which have a combined capacity of $135 million (see below for debt numbers pro forma for the redemption of subordinate debt). The reduced availability under the $300 million revolver at the end of the most recent quarter reflects the borrowing base calculation rather than borrowings under the facility.
Total debt pro forma for the July 2012 redemption of the subordinate debt is estimated to be $1 billion and consists principally of:
--$257 million of senior unsecured floating rate notes due June 2014;
--$500 million of senior unsecured 7% notes due 2019; and
--Approximately $200 million outstanding under the company's revolving credit facilities, roughly $150 of which was drawn to refund the subordinated notes.
The Recovery Ratings (RRs) for Sanmina reflect Fitch's recovery expectations under a distressed scenario, as well as Fitch's expectation that the enterprise value of Sanmina, and hence recovery rates for its creditors, will be maximized in a liquidation scenario rather than as a going concern. In estimating liquidation, Fitch applies advance rates of 80%, 20%, and 10% to Sanmina's accounts receivables, inventories, and property, plant, and equipment balances, respectively. Fitch arrives at an adjusted reorganization value of $876 million after subtracting administrative claims. As is standard with Fitch's recovery analysis, the revolvers and short term credit facilities are fully drawn and cash balances fully depleted to reflect a stress event. The 'RR1' for Sanmina's secured credit facility and short term credit facilities reflects Fitch's belief that 91%-100% recovery is realistic. The 'RR3' for Sanmina's unsecured notes reflects Fitch's belief that 51-70% recovery is realistic.
WHAT COULD TRIGGER A RATING ACTION?
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--Consistent organic revenue growth reflecting success in management's strategy and execution;
--Sustained EBITDA margins in excess of 5% and more consistent cash flow through the business cycle;
--Sustained leverage metrics materially below 3.0x
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Revenue and margin declines signifying execution missteps in management's strategy and reduced competitiveness in the EMS industry;
--Significant debt financed acquisitions or share repurchases that would materially increase leverage above 4.0x.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Rating Global Technology Companies Sector Credit Factors' (Sept. 20, 2010);
--'Evaluating Corporate Governance' (Dec. 6, 2010).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Rating Global Technology Companies - Specific Rating Factors
Evaluating Corporate Governance
Source(s) : Fitch Ratings
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