S&P Affirms Long-Term, Short-Term Ratings on Fiat Chrysler Automobiles (FCAU)

Standard & Poor's Ratings Services today affirmed its 'BB-' long-term and 'B' short-term corporate credit ratings on automotive manufacturer Fiat Chrysler Automobiles NV (NYSE: FCAU).

At the same time, we assigned a 'B-' issue rating and a '6' recovery rating to the proposed $2.5 billion mandatory convertible bond (MCB). The amount and terms of this offering are subject to market conditions.

The affirmation reflects our view that the MCB issuance and planned sale of common shares supports FCA's financial risk profile and thereby mitigates downside risks to the ratings. Such risks may have otherwise arisen from ongoing negative free operating cash flows (FOCF), caused by sizable ongoing capital expenditures (capex) related to its 2014-2018 business plan, against a backdrop of weaker operating conditions in certain regional markets, such as Latin America. Whereas previously we were forecasting a ratio of funds from operations (FFO) to debt of about 10%-13% for 2014 and 2015, we now expect a slightly stronger level of 12%-14%. This more comfortably positions the company's leverage metrics in line with the rating, albeit still at the weaker end of the range.

FCA has also announced plans to separate its 90% stake in the Ferrari luxury car business during 2015, by way of a public offering of FCA's interest in Ferrari equal to 10% of Ferrari's outstanding shares, and a distribution of FCA's remaining Ferrari shares to FCA shareholders. We see this as slightly negative for the company's credit quality. Ferrari accounts for just a small component of the group's revenues (€2.3 billion in 2013); however, due to its higher operating profit margin of about 16%, we consider that its disposal will slightly dilute FCA's profitability and business diversity. We note that FCA expects to lower its own net industrial debt as a result of the transaction by about €0.7 billion.

Our "fair" business risk profile assessment is unchanged and reflects our view of the group's well-established market positions in passenger cars and light trucks, good regional diversity, and improving market conditions in the U.S. These strengths are partly offset by the group's focus on the small to midsize car and light truck segments, including low capacity utilization and ongoing overcapacity in the European volume segment, where losses have continued, albeit narrowed. Furthermore, market conditions in Latin America have deteriorated significantly.

Our "aggressive" financial risk profile assessment is unchanged and reflects the significant cash balances of €7.4 billion in its industrial business (excluding cash held by Chrysler) as at Sept. 30, 2014. Not only does this provide a buffer against a market downturn, it could be used as a source of financing. This is partly offset by our forecast that FOCF will be negative in both 2014 and 2015 at €2.0 billion-€2.5 billion because of sizable capex of €8.0 billion-€9.0 billion per year in support of the company's expansion plans

Our base case is unchanged and assumes:

• Low-single-digit revenue growth in 2014 and 2015, mainly due to higher volumes in North American Free Trade Agreement countries and Asia-Pacific, offsetting weaker conditions in Latin America and Europe, the Middle East, and Africa.
• For 2014, we forecast a reported EBITDA margin (before unusual items) of 8.5%-9.0%, with a slight improvement to 9.0%-9.5% in 2015.
• We forecast negative free operating cash flows of €2.0 billion-€2.5 billion in both 2014 and 2015, depending in part on the level of capex, which we expect to be €8.0 billion-€9.0 billion in each year.
• No expected dividends during 2014 and 2015.
• We continue to exclude sizable cash balances in Chrysler from our leverage and liquidity analysis.

Based on these assumptions, we arrive at the following credit measures:

• During 2014 and 2015, we see the ratio of FFO to debt in the 12%-14% range, and the ratio of adjusted debt to EBITDA in the 4.0x-4.5x range.

We expect FCA and Chrysler to continue to operate their treasury and liquidity separately, as FCA's access to Chrysler's cash flow and retained cash is significantly constrained by terms and conditions in Chrysler's debt agreements. As a result, we exclude Chrysler's cash balances from our leverage metrics and liquidity analysis.

That said, during 2015 and 2016 and in line with our existing expectations, we anticipate that FCA and Chrysler will begin to operate its treasury and liquidity on a more integrated basis, as it seeks to remove restrictions on the movement of cash within the group. This could allow FCA to gain full access to Chrysler's cash flow and retained cash. On this basis, we would expect to factor this development into our ratings once we see the company take concrete steps in this direction. We continue to assess FCA's business and financial risk profiles on a consolidated basis. We also exclude FCA's financial services activities from our analysis.

As of Sept. 30, 2014, Standard & Poor's-adjusted debt was €31.3 billion, which is about €5.1 billion higher than at year-end Dec. 31, 2013. We make analytical adjustments to reported gross debt of €32.9 billion, mainly by adding €6.9 billion for pensions, subtracting €4.7 billion for captive finance debt, and €5.4 billion for surplus cash. For our surplus cash adjustment, we deduct €11.2 billion, which is held by Chrysler and the captive finance operations, and apply a 25% haircut to the remaining €7.2 billion. We also add €1.4 billion to debt for trade receivables sold and operating leases. On this basis, we estimate that the ratios of FFO to debt and debt to EBITDA were approximately 10% and 5.4x, respectively, for the year to Sept. 30, 2014.

We assess the proposed MCB as having "high" equity content for an amount representing the nominal amount that will be issued, minus the make-whole coupon amount that the company could pay in cash in certain cases of an early conversion. The latter amount gradually decreases over time.

At conversion, the bonds convert into FCA shares. In line with our criteria, we base the "high" equity content ascribed to the bulk of the issue on the bonds' maturity to conversion of not more than two years; the bonds' deep subordination; the inclusion of a conversion price floor no less that the common share price at the time of initial issuance; and the bonds' coupon deferability at the issuer's discretion. Our assessment reflects our analysis of draft documentation and is subject to our review of the final terms and conditions.

Consequently, in our calculation of FCA's credit ratios, we treat 100% of the principal minus the maximum make-whole amount and accrued interest as equity rather than as debt, and the related payments as equivalent to a common dividend, in line with our hybrid capital criteria. The make-whole premium is instead treated as debt.

According to our criteria, the three-notch difference between our 'B-' rating on the hybrid notes and our 'BB-' corporate credit rating on FCA reflects two notches for the notes' subordination because the corporate credit rating on FCA is speculative grade; and an additional notch for the optional deferability of interest. The notching of the securities takes into account our view that there is a relatively low likelihood that FCA will defer interest payments. Should our view change, we may significantly increase the number of downward notches that we apply to the issue rating, and more quickly than we might take a rating action on FCA.

The stable outlook on FCA reflects our view that the company will demonstrate credit metrics that we consider to be consistent with the ratings over 2014 and 2015. These are, namely, adjusted debt to EBITDA of 4.0x-4.5x, and FFO to adjusted debt of 12%-14%. The FFO-to-debt ratio remains at the weaker end of the range for the rating.

We anticipate that FCA will begin to take measures to facilitate cash flow movements within the group during 2015 and 2016, and on this basis, we would expect to factor this development into our ratings once we see FCA take tangible steps.

We could lower the long-term rating if FCA exhibits weaker-than-expected operating cash flows or profitability--for example, if results in Latin America are persistently weak--and FCA also maintains its high level of capex, such that leverage metrics become sustainably weaker than adjusted debt to EBITDA of above 5.0x and FFO to debt of below 12%.

We could raise the long-term rating if FCA achieves far stronger credit metrics on a sustainable basis--such as debt to EBITDA below 4.0x and adjusted FFO to debt above 20%--and reduces its absolute amount of adjusted debt. Actions to permanently strengthen access to Chrysler's cash flows and retained cash balances could also result in a positive rating action.

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