Moody's Cuts STMicroelectronics (CTM) Long-Term Rating to 'Baa3', Outlook Stable
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Moody's Investors Service has today downgraded to Baa3 from Baa2 the long-term issuer rating of STMicroelectronics N.V. (NYSE: STM), a global semiconductor company. The outlook assigned to the ratings is stable.
RATINGS RATIONALE
Today's rating action reflects Moody's view that ST's profitability and free cash flow generation will improve slower than previously expected in the coming quarters after a period of operating losses in 2013. It also reflects the challenges around ST's ability to improve profitability at some of its lower margin products and to move the company towards a higher level of profitability and free cash flow generation on a sustainable basis through the cycle following the exit of the loss making ST-Ericsson joint venture. The downgrade follows the company's recent announcement on October 22, 2013 that its target to achieve an operating margin of about 10 % will be postponed until mid-2015.
Moody's expects ST's operating margins to improve only to the low-to-mid-single-digit range and the company to return to only modest positive free cash flow generation after dividends in 2014. These projections incorporate the expectation of modest revenue growth as well as the targeted reduction in its quarterly net operating expenses to $600-650 million. However, these projections still lag the improvements that Moody's previously incorporated into the rating and position the company weakly against other similar rated semiconductor companies.
The downgrade of the rating also reflects our expectation that, despite the termination of the loss-making ST-Ericsson joint venture, free cash flow generation after dividend payments will be only moderately positive.
Uncertainties remain around the timing and ability of ST to achieve a higher level of profitability on a consolidated level and generate material positive free cash flow after dividends through the cycles of the volatile semiconductor industry. Moody's regards ST's 10% operating margin target by mid-2015 (postponed from 2014 following third quarter results 2013) as ambitious as it depends to a significant degree on the success of recent design wins shifting its portfolio mix to higher value products, which support gross margin expansion, as well as volume growth. The group's 10% margin target requires $2.25-2.3 billion quarterly revenues, which compares with just $2.0 billion expected for the fourth quarter of 2013.
In the third quarter, ST's Embedded Processing Solutions (EPS) segment reported a negative operating margin of 2% as a result of the loss-making digital convergence (DCG) business, weak profitability at its imaging (IBP) sub-segment and the negative impact of the ST-Ericsson legacy products. Moody's believes that ST will find it challenging to improve profitability in the EPS segment to the target level of around 5% by mid-2015, despite this segment including the rather profitable microcontrollers unit. The Sense & Power and Automotive Products (SPA) segment reported an operating margin of 6% in the same quarter, below the target level of approximately 15%. However, we are more confident that the SPA segment can reach its targeted margin level over time, which is supported by historical operating margins above 10% during the peak in 2011.
ST's rating remains supported by (1) the company's scale and position as one of the largest global semiconductor companies; (2) the diversity of its operations by products, customers and regions; (3) the group's limited adjusted net debt position ($380 million per September 2013, 3.5x debt/EBITDA per 30 September 2013, still burdened by effects from the ST-Ericsson JV, we estimate gross debt/EBITDA to significantly improve in 2014 to around 1.5x by year-end) and solid liquidity profile; and (4) the expected improvements in the company's profitability and free cash flow generation following the termination of the ST-Ericsson joint venture at the end of August 2013.
However, the rating is constrained by (1) ST's exposure to the inherently volatile and cyclical semiconductor industry and the ongoing challenges the company faces to sustain a pipeline of design wins against competitors; (2) its weak credit metrics over the past three years as a result of (a) mounting losses at the consolidated ST-Ericsson joint venture and (b) marginal profitability at the group's core business, the latter driven by losses at its digital sub-segment and recent weakness in the IBP and industrial & power discrete (IPD) sub-segments; (3) ST's higher and less flexible cost base compared with US and Asian peers, with five of its six front-end fabrication facilities being located in Europe and exposing the company to adverse movements in the exchange rate of the euro against the US dollar; (4) and a relatively high dividend payout compared to consolidated operating cash flow generation.
RATIONALE FOR STABLE OUTLOOK
The stable rating outlook reflects Moody's expectation that ST will maintain a financial policy that is based on (1) shareholder returns being balanced against operating cash flow generation; (2) limited amounts of financial gross debt; and (3) an excellent liquidity profile, which provides ST with the necessary time to recover its operating performance over the next 12-18 months.
WHAT COULD CHANGE THE RATING UP/DOWN
A rating upgrade could be triggered if ST's measures to reduce costs and asset intensity prove effective and the group demonstrates good execution of its business model such that its operating margin (1) grows to a higher sustainable range in the high single-digit range through the cycle; and (2) is around 10% at peak levels. In addition, a rating upgrade would require that ST returns to material positive free cash flow generation.
Further negative rating pressure could be prompted by (1) sustained erosion of market share, revenue contraction or ASP (average selling price pressure) pressure as a result of loss of technological leadership; (2) failure to improve operating margins to the low-to-mid-single-digit range over the next 12-18 months; and (3) continued negative free cash flow generation after dividends in 2014 and debt/EBITDA above 2.5x for an extended period of time.
PRINCIPAL METHODOLOGY
The principal methodology used in this rating was the Global Semiconductor Industry Methodology published in December 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
RATINGS RATIONALE
Today's rating action reflects Moody's view that ST's profitability and free cash flow generation will improve slower than previously expected in the coming quarters after a period of operating losses in 2013. It also reflects the challenges around ST's ability to improve profitability at some of its lower margin products and to move the company towards a higher level of profitability and free cash flow generation on a sustainable basis through the cycle following the exit of the loss making ST-Ericsson joint venture. The downgrade follows the company's recent announcement on October 22, 2013 that its target to achieve an operating margin of about 10 % will be postponed until mid-2015.
Moody's expects ST's operating margins to improve only to the low-to-mid-single-digit range and the company to return to only modest positive free cash flow generation after dividends in 2014. These projections incorporate the expectation of modest revenue growth as well as the targeted reduction in its quarterly net operating expenses to $600-650 million. However, these projections still lag the improvements that Moody's previously incorporated into the rating and position the company weakly against other similar rated semiconductor companies.
The downgrade of the rating also reflects our expectation that, despite the termination of the loss-making ST-Ericsson joint venture, free cash flow generation after dividend payments will be only moderately positive.
Uncertainties remain around the timing and ability of ST to achieve a higher level of profitability on a consolidated level and generate material positive free cash flow after dividends through the cycles of the volatile semiconductor industry. Moody's regards ST's 10% operating margin target by mid-2015 (postponed from 2014 following third quarter results 2013) as ambitious as it depends to a significant degree on the success of recent design wins shifting its portfolio mix to higher value products, which support gross margin expansion, as well as volume growth. The group's 10% margin target requires $2.25-2.3 billion quarterly revenues, which compares with just $2.0 billion expected for the fourth quarter of 2013.
In the third quarter, ST's Embedded Processing Solutions (EPS) segment reported a negative operating margin of 2% as a result of the loss-making digital convergence (DCG) business, weak profitability at its imaging (IBP) sub-segment and the negative impact of the ST-Ericsson legacy products. Moody's believes that ST will find it challenging to improve profitability in the EPS segment to the target level of around 5% by mid-2015, despite this segment including the rather profitable microcontrollers unit. The Sense & Power and Automotive Products (SPA) segment reported an operating margin of 6% in the same quarter, below the target level of approximately 15%. However, we are more confident that the SPA segment can reach its targeted margin level over time, which is supported by historical operating margins above 10% during the peak in 2011.
ST's rating remains supported by (1) the company's scale and position as one of the largest global semiconductor companies; (2) the diversity of its operations by products, customers and regions; (3) the group's limited adjusted net debt position ($380 million per September 2013, 3.5x debt/EBITDA per 30 September 2013, still burdened by effects from the ST-Ericsson JV, we estimate gross debt/EBITDA to significantly improve in 2014 to around 1.5x by year-end) and solid liquidity profile; and (4) the expected improvements in the company's profitability and free cash flow generation following the termination of the ST-Ericsson joint venture at the end of August 2013.
However, the rating is constrained by (1) ST's exposure to the inherently volatile and cyclical semiconductor industry and the ongoing challenges the company faces to sustain a pipeline of design wins against competitors; (2) its weak credit metrics over the past three years as a result of (a) mounting losses at the consolidated ST-Ericsson joint venture and (b) marginal profitability at the group's core business, the latter driven by losses at its digital sub-segment and recent weakness in the IBP and industrial & power discrete (IPD) sub-segments; (3) ST's higher and less flexible cost base compared with US and Asian peers, with five of its six front-end fabrication facilities being located in Europe and exposing the company to adverse movements in the exchange rate of the euro against the US dollar; (4) and a relatively high dividend payout compared to consolidated operating cash flow generation.
RATIONALE FOR STABLE OUTLOOK
The stable rating outlook reflects Moody's expectation that ST will maintain a financial policy that is based on (1) shareholder returns being balanced against operating cash flow generation; (2) limited amounts of financial gross debt; and (3) an excellent liquidity profile, which provides ST with the necessary time to recover its operating performance over the next 12-18 months.
WHAT COULD CHANGE THE RATING UP/DOWN
A rating upgrade could be triggered if ST's measures to reduce costs and asset intensity prove effective and the group demonstrates good execution of its business model such that its operating margin (1) grows to a higher sustainable range in the high single-digit range through the cycle; and (2) is around 10% at peak levels. In addition, a rating upgrade would require that ST returns to material positive free cash flow generation.
Further negative rating pressure could be prompted by (1) sustained erosion of market share, revenue contraction or ASP (average selling price pressure) pressure as a result of loss of technological leadership; (2) failure to improve operating margins to the low-to-mid-single-digit range over the next 12-18 months; and (3) continued negative free cash flow generation after dividends in 2014 and debt/EBITDA above 2.5x for an extended period of time.
PRINCIPAL METHODOLOGY
The principal methodology used in this rating was the Global Semiconductor Industry Methodology published in December 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
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