Fitch Lowers Siemens (SI) IDR Rating from 'A+' to 'A'; Outlook Stable

August 2, 2013 8:21 AM EDT
Fitch Ratings has downgraded Siemens AG's (NYSE: SI) Long-term Issuer Default Rating (IDR) and senior unsecured rating to 'A' from 'A+', and the subordinated rating of Siemens' two hybrid bonds to 'BBB+' from 'A-'. The Short-term IDR has been affirmed at 'F1'. The Outlook is Stable.

The downgrade reflects Fitch's expectation that Siemens' strategic and financial performance is unlikely to remain commensurate with a 'A+' rating during the horizon of our forecasts. Despite a strong performance through the recession, a continuing trend of profitability erosion since 2010, the increased magnitude of margin declines as evidenced by Q313 figures, and insufficient progress with restructuring measures had already placed Siemens at the low-end of its current rating headroom. Based on this, Fitch forecasts only moderate improvements in profitability, free cash flow (FCF) generation and leverage metrics, in any case, below a level commensurate with a 'A+' rating.

The downgrade recognises that the appointment of a new CEO, Joe Kaeser, is a positive development. However, our revised view of the extended nature of the challenges facing the group includes greater scepticism about the speed and ultimate success with which targeted change can be made in an organisation of Siemens' size and complexity. Diversity in operations requires a cohesive approach at the senior executive level, which Fitch considers has been lacking in recent years and will be slow to re-establish, especially concurrently with a fundamental rethink of which business lines the group will operate.

The severity of this challenge is evidenced by the persistence of margin and cash flow decline, which will continue to suffer from the dilutive effect of the current order book. As a result, the strategic improvement associated with a change in CEO serves to support a Stable Outlook at the new rating, rather than an expectation of a return to 'A+' parameters within the timeline of our rating horizon.

Margin and FCF Weakness to only Partially Reverse
Fitch expects EBITDAR margins for FY13 to be 10.8% and FCF margins below 1%, which are too weak for a 'A+' rating level, but remain in line with a 'A' IDR in accordance with Fitch's sector credit factors for capital goods companies. Fitch expects moderate improvements over the next few years, with EBITDAR margins going up to 12.5% and FCF margins increasing to 1.5%-2% by end-2015.

Acquisitions and Project Charges
Cash flows will be constrained by additional restructuring charges of up to EUR1bn in FY13, and integration costs related to the recent Invensys Rail acquisition. Project charges related to high-speed train deliveries and technically challenging off-shore transmission project in the North Sea are expected to exacerbate the problems.

Challenging Competitive Environment
Fitch believes that the intensity of competition for Siemens' core products will increase as demand softens, in particular the company's industrial short-cycles product business and more broadly in emerging markets like China.

Fitch expects Siemens to continue to operate at elevated leverage metrics. FFO adjusted net leverage (including the financial services operations) is forecast to be around 2.5x, while potential for deleveraging from operational cash flow remains limited. Importantly, industrial operations leverage is also expected to remain high for a 'A+' rating in the foreseeable future.

Strong Business Profile
Siemens benefits from a high degree of product and geographical diversification as the world's second-largest capital goods producer. It holds dominant market positions in many sectors, serves a global customer base and has significant emerging-markets presence, where it generates about one-third of its revenue. This makes the group resilient to adverse changes in individual markets or regions.

Stability Through the Cycle
The group was relatively resilient during the recent recession, despite its exposure to the cyclical capital goods industry. The group was one of the few Fitch-rated capital goods players which increased its margins on flat revenue during FY09 and FY10, and as a result, remained FCF positive throughout the downturn, supporting the Stable Outlook.

The ratings are solidly positioned at the current rating level, and also entail headroom for time delays in implementation of the restructuring program or further margin pressure.

The ratings could be upgraded if FFO adjusted net leverage (including financial services) is sustainably below 2.5x, and/or negative or neutral for industrial operations, FCF margin reaches 5% and EBITDAR-based profitability increases to 15%. .

The ratings could be downgraded if FCF margins remain below 1.5% and EBITDAR margins decline to 10% or lower. Alternatively, negative rating action may be taken if a recurrence of aggressive expansion plans or shareholder-friendly policies at the expense.

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