Fitch Rates Clarios Proposed First Lien Secured Term Loans 'B+'/'RR3'

Published: 2025-01-09 04:53:16 ET BWA

Fitch Ratings has assigned a rating of 'B+' with a Recovery Rating of 'RR3' to Clarios Global LP's (Clarios Global) proposed first lien secured USD and EUR term loans.

The proposed loans will be pari passu with Clarios Global's existing first lien debt.

Clarios Global is a subsidiary of Clarios International Inc. (Clarios). Both Clarios and Clarios Global have a Long-Term Issuer Default Rating (IDR) of 'B' with a Stable Rating Outlook.

Fitch recently revised Clarios' Outlook to Stable from Positive, reflecting the expected increase in leverage resulting from the company's plan to issue debt to fund a distribution to its sponsors.

Key Rating Drivers

Proposed Term Loans: On Jan. 6, 2025, Clarios announced that it plans to issue debt to fund a special distribution to its sponsors. Proceeds from both the proposed first lien secured USD and EUR term loans will be used to fund a portion of that planned distribution. The total distribution is planned at $4.5 billion.

Leverage Expected to Rise Significantly: Between fiscal YE 2020 and YE 2024, Clarios' debt (including off-balance-sheet factoring) declined by about $2.1 billion. Over this time, EBITDA gross leverage (calculated according to Fitch's methodology) declined to 4.6x from 10.0x. The company reduced debt through term loan prepayments, open-market purchases of outstanding notes and the retirement of its 2025 senior secured notes with cash on-hand. Fitch's EBITDA calculation currently excludes Clarios' Inflation Reduction Act (IRA) Section 45 tax credits.

Looking ahead, Fitch expects gross EBITDA leverage to return to above 6.0x due to the incremental debt to fund the special distribution. Fitch now expects leverage at fiscal YE 2025 to be near the mid-6x range, including off-balance-sheet factoring. Despite the increase in debt, Fitch expects Clarios to have opportunities to reduce debt over the long term. EBITDA leverage could decline toward 6.0x or lower over the next couple years if the company targets FCF toward debt reduction.

Solid FCF Expected: Fitch expects Clarios to generate solid FCF over the next several years. However, near-term FCF margin will likely be held back by increased cash interest expense on the higher debt. Fitch expects Clarios to generate FCF margins (according to Fitch's methodology) around 4.5% in fiscal 2025, down from 5.8% in fiscal 2024. Over the long term, the shift toward advanced batteries and continued cost savings could increase the FCF margin above 5.0%. Fitch expects capex as a percentage of revenue to be in the 4.0%-4.5% range over the next few years.

Sub-3.0x EBITDA Interest Coverage Expected: Fitch expects Clarios' EBITDA interest coverage to fall below 3.0x following the issuance of the new debt. Actual coverage will depend on the pricing of the new debt, but using market interest rates, Fitch expects EBITDA interest coverage to be in the upper-2x range for the next couple of years. Actual EBITDA interest coverage at fiscal YE 2024 was 3.4x. Clarios typically uses hedges to convert a portion of its floating-rate debt to fixed rates, mitigating the effect of fluctuating rates on the company's interest expense.

Derivation Summary

Clarios has a very strong competitive position as the largest low-voltage vehicle battery manufacturer in the world, with the company responsible for about one-third of the industry's total global production. Although Clarios counts many global original equipment (OE) manufacturers as customers, roughly 80% of its sales are typically derived from the global vehicle aftermarket.

Clarios' strong aftermarket presence provides it with a more stable revenue stream through the cycle than auto suppliers that are predominantly tied to new vehicle production, such as BorgWarner Inc. (BBB+/Stable) or Aptiv PLC (BBB/Stable). The company's heavy aftermarket weighting makes it more comparable to global tire manufacturers, such as Compagnie Generale des Etablissements Michelin (A-/Stable) and The Goodyear Tire & Rubber Company (BB-/Negative) or other suppliers with a significant aftermarket concentration, such as First Brands Group LLC (B+/Stable) or Tenneco Inc. (B/Positive).

Clarios' margins are strong for an auto supplier, with forecasted EBITDA margins (according to Fitch's methodology) running in the high teens in percentage terms over the next several years, which is stronger than many investment-grade auto suppliers, such as BorgWarner or Aptiv. It's forecasted FCF margins in the low- to mid-single-digit range are also consistent with investment-grade auto suppliers. However, Clarios' leverage is relatively high and consistent with auto suppliers in the 'B+' rating category.

Over the long term, Fitch expects Clarios' leverage to continue to decline as a result of higher EBITDA from sales growth tied to the rising global vehicle population and a richer mix of advanced batteries. Fitch also expects the company to continue to actively seek opportunities to reduce debt, which would further accelerate leverage reduction.

Parent/Subsidiary Linkage

Fitch rates the IDRs of Clarios and its Clarios Global subsidiary on a consolidated basis, using the weak parent/strong subsidiary approach and open access and control factors, as discussed in Fitch's 'Parent and Subsidiary Linkage Rating Criteria'. This is based on the entities operating as a single enterprise with strong legal and operational ties.

Key Assumptions

Clarios Global issues new senior secured first lien debt, which is used to fund a distribution to the company's sponsors;

Global automotive battery demand rises in the low-single-digit range in fiscal 2025, due to ongoing increases in global vehicle production and replacement battery demand. Beyond 2025, global demand continues to rise in the low single-digit range annually;

In addition to volume growth, revenue is supported over the next several years by the mix shifting to higher-priced advanced batteries, as well as modest price increases on traditional batteries;

Margins are roughly flat in fiscal 2025 (excluding section 45x credits) and then generally grow over the next several years as a result of operating leverage on higher production levels, positive pricing and mix, and savings associated with cost-reduction initiatives;

Capex as a percentage of revenue is in the 4.0%-4.5% range over the next few years;

The company uses a portion of its excess cash to reduce debt over the next several years;

Most debt maturities are refinanced at prevailing interest rates prior to maturity;

Fitch has not incorporated the effect of any potential IPO into its forecasts;

Fitch has incorporated the following interest rate assumptions into its forecasts: SOFR of 4.05%, 3.74%, 3.65% and 3.57% in fiscal 2025, 2026, 2027 and 2028. EURIBOR: 1.87%, 1.94%, 2.02% and 2.12% in fiscal 2025, 2026, 2027 and 2028 respectively.

Recovery Analysis

Fitch's recovery analysis assumes Clarios would be considered a going concern (GC) in bankruptcy and would be reorganized rather than liquidated. Fitch has assumed a 10% administrative claim in the recovery analysis.

Clarios' recovery analysis reflects a potential severe downturn in vehicle battery demand and estimates the GC EBITDA at $1.6 billion, which reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which the valuation of the company would be based following a hypothetical default.

The GC EBITDA is about $200 million higher than the level used in Fitch's previous recovery analysis and incorporates changes to the company's business profile, including the shift toward advance batteries and cost-saving activities, which Fitch believes would increase the company's valuation. The sustainable, post-reorganization EBITDA is for analytical valuation purposes only and does not reflect a level of EBITDA at which Fitch believes the company would fall into distress.

The GC EBITDA considers Clarios' stable operations, high operating margins, significant percentage of aftermarket revenue and the nondiscretionary nature of its products. The $1.6 billion ongoing EBITDA assumption is 23% lower than Fitch's calculated actual EBITDA of $2.1 billion for fiscal 2024.

Fitch utilizes a 6.0x enterprise value (EV) multiple based on Clarios' strong global market position and the nondiscretionary nature of the company's batteries. In addition, Brookfield Asset Management Inc.'s acquisition of Clarios in 2019 valued the company at an EV over 8.0x (excluding expected post-acquisition cost savings). All of Clarios' rated debt is guaranteed by certain foreign and domestic subsidiaries.

According to Fitch's 'Automotive Bankruptcy Enterprise Values and Creditor Recoveries' report published in April 2024, 52% of auto-related defaulters had exit multiples above 5.0x, with 30% in the 5.0x to 7.0x range. However, the median multiple observed across 23 bankruptcies was only 5.1x.

Within the report, Fitch observed that 87% of the bankruptcy cases analyzed were resolved as a GC. Automotive defaulters were typically weighed down by capital structures that became untenable during a period of severe demand weakness, either due to economic cyclicality or the loss of a significant customer, or they were subject to significant operational issues.

While Clarios has a highly leveraged capital structure, Fitch believes the company's business profile is stronger than most of the issuers included in the automotive bankruptcy observations.

Consistent with Fitch's criteria, the recovery analysis assumes that $1.7 billion of off-balance-sheet factoring is replaced with a super-senior facility that has the highest priority in the distribution of value. Fitch also assumes a full draw on the $800 million ABL revolver, which was not constrained by the borrowing base limit as of Sept. 30, 2024. The ABL receives second priority in the distribution of value after the factoring. Due to the ABL's first lien claim on ring-fenced collateral, the facility receives a Recovery Rating of 'RR1' with a waterfall generated recovery computation (WGRC) in the 91%-100% range.

The analysis also assumes a full draw on the $800 million cash flow revolver. Including this, the first lien secured debt totals $11.7 billion outstanding (including the estimated new debt) and receives a lower priority than the ABL in the distribution of value hierarchy, in part due to its second lien claim on the ABL's collateral. This results in a Recovery Rating of 'RR3' with a WGRC in the 50%-70% range.

The $1.6 billion of outstanding senior unsecured notes has the lowest priority in the distribution of value. This results in a Recovery Rating of 'RR6' with a WGRC in the 0%-10% range, owing to the significant amount of secured debt positioned above it in the distribution waterfall.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Gross EBITDA leverage above 7.0x without a clear path to de-levering on a sustained basis;

EBITDA interest coverage approaching 1.5x on a sustained basis;

A decline in the Fitch-calculated EBITDA margin below 10% and FCF margin near 1.0%, both on a sustained basis.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Financial policy-driven debt reduction that leads to gross EBITDA leverage of 5.5x on a sustained basis;

EBITDA interest coverage of 2.5x on a sustained basis;

Fitch-calculated EBITDA margins in the low teens in percentage terms and FCF margin of 2.5%, both on a sustained basis.

Liquidity and Debt Structure

Solid Liquidity: Liquidity as of Sept. 30, 2024, included $344 million of cash and cash equivalents, augmented by significant revolver capacity. Revolver capacity includes both an $800 million ABL facility and an $800 million first lien secured cash flow revolver. As of Sept. 30, 2024, a total of about $1.6 billion was available on the two revolvers, with full availability on the cash flow revolver and $753 million available on the ABL, after accounting for $47 million of letters of credit backed by the facility.

The ABL and revolver both mature in 2028. However, a springing maturity provision that applies to both facilities could accelerate the maturities to as early as February 2026 if the company's senior secured notes due 2026 are not refinanced or redeemed prior to that time.

Debt obligations (excluding Fitch's factoring adjustments) are light in FY 2025, but the company has $1.7 billion of debt maturing in FY 2026 and $1.6 billion maturing in FY 2027.

Fitch expects Clarios' FCF to generally be sufficient to cover its seasonal cash needs. As a result, based on its criteria, Fitch has treated all of Clarios' cash as readily available.

Debt Structure: As of Sept. 30, 2024, Clarios had about $9.6 billion of debt outstanding, including off-balance-sheet factoring. This consisted of $6.4 billion of first lien secured debt, comprising U.S. dollar- and euro-denominated term loans and secured notes, as well as about $1.6 billion of senior unsecured notes. The remaining debt consisted of $1.7 billion of off-balance-sheet factoring. Fitch excludes finance leases from its debt calculations.

Clarios' term loans provide it with prepayment flexibility. However, Clarios also has a significant amount of non-amortizing debt that could lead to refinancing risk over the long term. That said, the company's senior secured notes due 2026, as well as its senior unsecured notes, became callable in May 2022.

Issuer Profile

Clarios is the world's largest manufacturer and distributor of low-voltage, advanced automotive batteries. It provides one in every three automotive lead-acid batteries globally, servicing cars, heavy duty trucks, motorcycles, marine and power sports vehicles in the OE and aftermarket channels.

Date of Relevant Committee

19 December 2024

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

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ESG Considerations

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