Frankfurt am Main, December 12, 2012 -- Moody's Investors Service today left the positive outlook on Invensys plc corporate family rating unchanged while also affirming Invensys' Ba1 corporate family rating and probability of default rating.
The recent announcement of Invensys to dispose of its rail division to Siemens for a total amount of GBP 1,742 million improves Invensys' positioning in the Ba1 rating category strongly as it enables Invensys to fully cover its sizeable pension deficit, payout a sizeable dividend and have cash available to further develop its remaining businesses. However, the Ba1 rating continues to reflect i) the company's still relatively low and recently declining operating margins (6.6% on a LTM basis and around 8-9% on average over the past five years, based on Moody's adjusted data), ii) positive albeit modest and declining free cash flow generation - 4% of revenues on an LTM basis and approximately 5% of revenues on average over the past five years, based on Moody's adjusted data -, but also iii) a very solid financial profile - on an Moody's adjusted basis - and strong liquidity, particularly in view of the planned disposal of the Rail business.
The positive outlook on the rating reflects Moody's expectation that despite the disposal of the higher but declining margin Rail business, Invensys will still be able to improve and sustain operating margins in the 10-15% range and to generate meaningful free cash flow in a 5-10% range in percentage of revenues. Pro-forma for the sale of Invensys Rail, the company's low adjusted leverage gives it significant strategic flexibility to boost its most profitable businesses, in particular its industrial software activities. Future potential M&A activity to boost such activities would not change Moody's positive outlook, provided that the company's main debt ratios remain in line with the current rating category -- for instance, for the Ba rating category we expect an interest coverage in a 3-4x range.
Moody's views Invensys' very low prospective leverage as an enhancing factor of the group's overall credit risk profile. Management's commitment to maintain a low leverage on a Moody's adjusted basis is a further positive factor in our evaluation, and could allow the company to achieve a higher rating even if its operating margins and free cash flow generation remain at the low end of the expected ranges (see above).
Assuming the successful completion of the sale of Invensys' Rail business, the group will generate approximately GBP 1.8 billion in revenues, of which 72% from industrial software, systems and equipment, and 28% of from commercial equipment and appliance controls. The largest end markets will be consumer cyclicals, oil and gas and general industries, each representing 20-25% each of the revenues of the new and smaller group. Emerging markets will represent approximately 35% of revenues and 52% of the order book. The retained businesses enjoy EBIT margins varying from mid single-digit in appliances to the mid twenties in industrial software applications. Growth rates also vary substantially across businesses, from 16% in software to a decline of 14% in appliances (2012 data versus 2011). In industrial software, the company has a leading niche market position which should allow it to continue to grow rapidly leveraging on its positions in emerging markets and through small bolt-on acquisitions.
Moody's recognizes the progress made by Invensys over the past five years in streamlining the company, focusing on the three businesses of rail, controls and operations management whilst improving its operating performance and (adjusted) credit metrics. However, Invensys' cash flow generation has weakened over the same period of time and the group has faced significant challenges in managing a large nuclear power project in China. The problems with the installation of safety systems at Chinese nuclear power stations had an impact on profit of GBP40 million last year plus an additional write-off of GBP20 million related to the Rail division. This has exposed the company's relatively small size in a market increasingly characterized by large and complex orders, both technically and financially.
The company's cash flow generation has weakened since 2009 when it generated GBP261 million of cash from operations and GBP199 million of free cash flow after capex (both on a Moody adjusted basis). In FY 2011/12, CFO and FCF amounted to GBP123 million and GBP18 million respectively. In the first six months of FY 2012/13, the company's CFO was a negative GBP8 million and FCF was a negative GBP49 million. However, we note that the recent performance of the company reflects major project milestones and temporary customer payment delays in the Rail division. We therefore expect such effects to be reversed in the second half of the year and the disposal of Invensys Rail to have a positive effect on the company's cash flow generation.
The pension agreement outlined in relation to the planned disposal of Invensys Rail would result in cash savings of over GBP40 million per annum, thus more than halving the company's top-up cash payments, and further enhancing the group's free cash flow generation in the medium term. In FY 2014, free cash flow is expected to be constrained by cash outflows of approximately GBP60 million related to tax and restructuring payments arising in relation with the planned disposal. The company expects annual cost savings of around GBP25 million from April 2014. Following the disposal of Invensys Rail, Moody's expects the remaining businesses to generate positive free cash flows before restructuring expenses and other cash outflows related to the disposal in a 5-10% range in percentage of revenues.
Invensys' adjusted debt ratios remained strong for the current rating category and will be further strengthened by the planned disposal. In the financial year ended March 2012, Moody's adjusted interest cover was 3.5x (EBITA to Interest expense) and 4.3x on a cash basis (FFO + Interest expense to Interest Expense), down from 4.8x and 5.8x in the previous year. Also, the ratio of FFO to debt was around 25%, down from approximately 35% a year before. Pro-forma for the sale of the rail business, the group's adjusted debt would be slashed and its debt-based metrics would substantially improve -- for instance, we estimate that pro-forma LTM RCF to gross debt would be well over 60% assuming that most operating leases remain with the group. Even on a gross debt basis, Invensys' debt metrics would therefore remain well above the requirements for the current rating category, giving the company substantial strategic flexibility and underpinning the currently positive outlook of its ratings.
Liquidity was more than adequate at the end of September 2012, with no outstanding debt maturities and a debt free net cash position of GBP175 million, down from GBP262 million in March, and two five-year bank facilities totaling GBP600 million signed in March 2012, of which GBP250 million is available for cash drawings and GBP350 million is available for the issuance of guarantees. The announcement of the sale of the rail business will boost the company's liquidity with approximately GBP372 million of the expected sale proceeds to be retained by the group to accelerate its strategic development through investment in the business and acquisitions.
Invensys's net pension liability rose to GBP490 million from GBP426 million in March reflecting lower discount rates applied in the calculation of the funding deficits. The bulk of the group's plan assets remain invested in fixed income instruments. Annual top-up cash payments amount to approximately GBP60-70 million. Assuming successful completion of the sale of the rail business, Invensys would make a GBP400 million contribution to the UK Pension Scheme, thus drastically reducing the reported net pension liability, and make an additional GBP225 million contribution to a be held in trust and to be used as a reserve for future potential funding requirements.
We expect Invensys to continue to benefit from its relatively large exposure to emerging markets -- representing well over half of its order book -- and thus somewhat insulated from the weak European markets. Invensys' diversified business profile, with software, consulting, and appliance controls, should also contribute to mitigate the effect of any potential further deterioration in the business cycle.
The rating could be upgraded if Invensys i) sustainably improves its operating margins over time above 10%; ii) generates meaningful levels of free cash flow - before growth investments and dividends -- in a 5-10% range in percentage of revenues; whilst iii) maintaining a solid financial profile with, for instance, an interest cover of at least 4 times on a Moody's adjusted basis. We note that the company already has debt metrics exceeding the requirements for the current rating but also that its profitability and free cash flow generation ability remain in line with the Ba rating category. The Ba1 rating and positive outlook factor in Invensys' strong debt metrics and expectations of operational improvements.
The rating is unlikely to be lowered based on the current operational and debt metrics. That said, it could be lowered if operating margins structurally remained at the low end of the 5-10% range and if its free cash flows -- before growth investments and dividends -- remained at the low end of the 0-5% range in percentage of revenues. Potential future M&A activity is unlikely to trigger any negative rating action given the company's currently and prospectively strong financial profile.
The principal methodology used in rating Invensys plc was the Global Manufacturing Industry Methodology published in December 2010. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
Invensys is a UK-listed technology company providing products and solutions for process control in a broad range of industries. Its revenue for the year ending March 2012 was about GBP 2.54 billion. The company comprises three divisions -- operations management, which provides hardware and software systems to control installations such as petrochemical plants; the rail business, which makes signaling systems; and controls, which provides controls for household and commercial appliances, such as washing machines. On November 28th, Invensys announced that it agreed to sell its Invensys Rail business to Siemens for GBP1,742 million in cash to refocus on industrial software, systems and controls.
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Roberto Pozzi Vice President - Senior Analyst Corporate Finance Group Moody'sDeutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Matthias Hellstern Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Releasing Office: Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 (C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
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