UPDATE: S&P Cuts Icahn Enterprises L.P. (IEP) to Junk

(Updated - May 17, 2016 12:35 PM EDT)

S&P Global Ratings said today it lowered its ratings on Icahn Enterprises L.P. (Nasdaq: IEP), including its long-term issuer credit rating and unsecured debt rating to 'BB+' from 'BBB-'. At the same time, we removed all of the ratings from CreditWatch. The outlook is stable. We also assigned a '3' recovery rating to IEP's senior unsecured notes. The '3' recovery rating indicates our expectation of meaningful recovery (upper half of the 50% to 70% range) in the event of a default.

"The downgrade reflects IEP's elevated LTV ratio, which we now expect to remain between 45%-60% over the next 12 months," said S&P Global Ratings credit analyst Clayton Montgomery. While part of this increase in leverage has come as the portfolio (most notably CVR Energy, Federal Mogul, and the investment segment) has deteriorated in value over the past year, it has also resulted from a substantial decrease in the amount of cash at IEP, which we net against debt in our LTV calculation. As of March 31, 2016, the IEP's LTV ratio was approximately 50%. However, we estimate that after quarter-end through May 13, 2016, IEP's large publicly traded positions declined by approximately $600 million, which would result in an LTV ratio of about 53%, holding all else equal.

We do not expect IEP to take action to decrease leverage at the current time, and management's leverage tolerance continues to be unclear--or at the very least elevated versus what we previously assumed. Even if IEP completes any divestitures (such as Fontainebleu) or upstreams cash from portfolio companies (such as Pep Boys), we would not expect for IEP to keep a meaningful amount of the proceeds in cash at IEP on a sustained basis. Instead, we believe IEP would very likely redeploy proceeds into new or existing portfolio companies or contribute to the investment segment. We also expect IEP to refinance the full amount of its $1.175 billion in senior unsecured notes due in January 2017, and we do not see an equity raise as a likely event at this point, especially given the performance in IEP's stock over the last year.

IEP's investment segment declined again in the first quarter, losing 12.8% of its value, after having negative returns in both 2015 and 2014. We would view further losses in this segment negatively, not only because it would have a leveraging effect on IEP's LTV ratio, but also because it would further pressure IEP's liquidity profile. We consider IEP's investment segment to be a secondary source of liquidity and an offset to IEP's low cash flow adequacy ratio. IEP redeemed $1.0 billion from the investment segment in the first quarter in connection with the Pep Boys acquisition, reducing its investment to $1.8 billion compared with $4.5 billion as of March 31, 2015. As of March 31, 2016, IEP's investment in the investment segment and cash covered debt by 37%, down significantly versus 65% as of Dec. 31, 2015, and 96% as of March 31, 2015.

IEP's cash flow adequacy ratio was approximately 1.5x in 2015, and we expect it to remain below 2x in 2016 (although it would be below 1x if we calculate this ratio using only recurring distributions). To the extent this ratio falls below 0.7x, we could consider lowering the rating if the decrease is not offset by an increase in cash at the holding company or a reduction in debt. IEP's distribution profile remains concentrated with two main holdings, CVR Energy and American Railcar Leasing, making up a substantial portion of total distributions. We view this unfavorably.

The stable outlook reflects our expectations that IEP will sustain an LTV ratio between 45%-60% and a cash flow adequacy ratio of above 0.7x over the next 12 months. It also reflects our expectation for IEP's portfolio quality, liquidity, and diversification to remain relatively unchanged over the next 12 months.

If IEP increases its LTV ratio to above 60% on what we believe is a sustainable basis or if IEP's cash flow adequacy ratio falls below 0.7x without a corresponding increase in cash to compensate for this, we could lower the rating. We could also lower the rating if IEP's portfolio becomes more concentrated, asset credit quality deteriorates, or investment performance continues to falter.

We could raise the rating if IEP's LTV ratio falls below 45% and we see meaningful indication that IEP's leverage tolerance has decreased. We could also raise the rating if the portfolio's liquidity, diversity, or asset credit quality increases substantially.

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