Moody's Raises Ratings on Allison Transmission (ALSN); See Prudence Exercised in Shareholder Distributions

Moody's Investors Service upgraded the ratings of Allison Transmission (NYSE: ALSN). Ratings that were upgraded include the Corporate Family Rating (CFR) to Ba3 from B1 and Speculative Grade Liquidity rating to SGL-1 from SGL-2. The rating outlook is stable.

RATINGS RATIONALE

The upgrade reflects Moody's expectation that Allison will manage the pace of future distributions to shareholders in a prudent manner. This prudence, combined with the company's highly competitive business position, should enable Allison to generate credit metrics that are solidly supportive of the Ba3 rating, and to preserve sufficient flexibility and liquidity to contend with cyclical downturns.

Moody's expects that Allison will continue to benefit from considerable operating strengths. It holds a commanding lead in the North American market for fully automatic transmissions used in commercial vehicles and other industrial applications, with the company estimating that it has a 61% global market share. This strong business position, combined with modest reinvestment requirements, should enable Allison to maintain EBITA margins exceeding 20% and to generate annual free cash flow of about $300 million.

Allison's target leverage range for net debt to EBITDA is 3.0x to 3.5x. This target range is down from leverage of approximately 7.7x that resulted from the company's 2007 LBO (not reflecting Moody's adjustments). At June 2014, Allison's leverage was 3.9x and we expect that this measure will fall to approximately 3.5x by fiscal year end -- the high end of its target range. As Allison has reduced debt and approached its targeted leverage range, the company's financial strategy has begun to prioritize the return of capital to shareholders. We believe that the company will pursue this capital distribution strategy in a manner that prudently balances business and financial risk, and that preserves credit metrics consistent with the Ba3 rating. Allison's key credit metrics (reflecting Moody's adjustments) at June 2014 include: debt to EBITDA of 4.1x; EBITA to interest of 3.4x; free cash flow to debt of 13%, and EBITA margin of 28%. Notwithstanding the company's shareholder distribution plans, we expect that there will be further moderate improvement in leverage and coverage measures.

The principal business risk facing Allison is the considerable cyclicality of the medium and heavy truck markets. A critical consideration in the Ba3 CFR was Allison's ability to preserve strong EBITA margins (approximately 20%) and positive free cash flow (approximately $80 million) during the 2008/2009 downturn. Importantly, we believe that Allison will maintain considerable operating flexibility to contend with future downturns, and that the pace of distributions to shareholders will be adjusted to accommodate any downturn-related reduction in free cash flow generation.

Important to the rating upgrade is Allison's maintenance of a strong liquidity position. At June 2014 the company's liquidity resources included: cash of $127 million, $453 million in availability under a revolving credit facility that matures in 2019, and free cash flow generation that exceeded $350 million for the twelve months through June 2014. The company has current debt maturities of only $18 million.

Allison's rating could improve further if the company maintains a strong business position and high margins, and if the company's financial strategy reflects adequate prudence in balancing business risk, the level of debt protection afforded to creditors, and the need to return capital to shareholders. Credit metrics that could support a higher rating include debt/EBITDA below 4x and EBITA/interest above 4.5x.

The rating would most likely face pressure from an overly aggressive shareholder distribution strategy. Metrics that could pressure the rating include debt/EBITDA above 4.5x and EBIT/interest below 3.0x

Upgrades:

..Issuer: Allison Transmission, Inc.

.... Probability of Default Rating, Upgraded to Ba3-PD from B1-PD

.... Speculative Grade Liquidity Rating, Upgraded to SGL-1 from SGL-2

.... Corporate Family Rating, Upgraded to Ba3 from B1

....Senior Secured Bank Credit Facility Aug 7, 2017, Upgraded to Ba2 from Ba3

....Senior Secured Bank Credit Facility Jan 27, 2019, Upgraded to Ba2 from Ba3

....Senior Secured Bank Credit Facility Aug 23, 2019, Upgraded to Ba2 from Ba3

....Senior Secured Bank Credit Facility Aug 7, 2017, Upgraded to a range of LGD3, 40 % from a range of LGD3, 41 %

....Senior Secured Bank Credit Facility Jan 27, 2019, Upgraded to a range of LGD3, 40 % from a range of LGD3, 41 %

....Senior Secured Bank Credit Facility Aug 23, 2019, Upgraded to a range of LGD3, 40 % from a range of LGD3, 41 %

....Senior Unsecured Regular Bond/Debenture May 15, 2019, Upgraded to B2 from B3

....Senior Unsecured Regular Bond/Debenture May 15, 2019, Upgraded to a range of LGD6, 91 % from a range of LGD6, 92 %

Outlook Actions:

..Issuer: Allison Transmission, Inc.

....Outlook, Remains Stable

The principal methodology used in this rating was Global Automotive Supplier Industry published in May 2013. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

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