Fitch: Chrysler LLC Ratings Unaffected by UAW Agreement; IDR at 'B+', Outlook StableCHICAGONY-FITCH-RATINGS/CHRYSLR
Chrysler LLC's (Chrysler) (Issuer Default Rating (IDR) 'B+'; Outlook Stable by Fitch) ratings are unaffected by the recent ratification of a new labor agreement with the United Auto Workers (UAW). The Rating of 'BB+/RR1' on the $7.5 billion first-lien senior secured term loan, as well as the $2 billion senior secured second-lien term loan, based on expectations of full recovery in a stress scenario, is likewise unaffected.Ratings for Chrysler reflect the intense competitive conditions in the North American auto market, an uncertain U.S. economic outlook entering 2008, declining market share, an unbalanced product mix, stresses in the supply base, high leverage in a high fixed-cost industry, and an ongoing restructuring program. Positives include the cost benefits and improved competitive position to be derived from the new UAW contract, Chrysler's relative success across a number of product segments, the benefits of its relationship with Daimler AG and international growth opportunities.
Fitch believes weakening economic growth in the U.S. has created an increasingly uncertain outlook for industry sales in 2008. In particular, the key pickup truck market will continue to be affected by depressed housing market conditions. Coupled with the pruning of its product line and a targeted reduction in fleet sales, share losses may continue and Chrysler will be challenged to halt revenue declines. Depending on the extent of the expected drop in industry sales, Chrysler will be challenged to reverse negative cash flows when factoring in restructuring costs. Incremental flexibility resulting from the new UAW contract, however, will allow Chrysler greater flexibility to size its production and costs to market conditions, thereby reducing downside risks and cash drains in a downturn.
Nevertheless, the current product pipeline -- including new minivans and the 2008 introductions of the Journey crossover, the Dodge Ram pickup and the low-volume, high-profile Challenger -- will help to support revenues and retail market share through 2008 and into early 2009. Although the minivan market continues to decline, the Exit of Ford Motor Company (IDR of 'B' with a Negative Outlook) and General Motors Corp. (GM) (IDR of 'B' with a Negative Outlook) from this market, and new features provided by the new Dodge and Chrysler offerings could further augment its market leading position. The new Journey crossover is aimed at one of the most rapidly-growing segments of the market where Ford and GM have both enjoyed recent success. Although the pickup truck market is not expected to rebound significantly through 2008, In line with expectations for the housing market, the numerous difficulties surrounding the Toyota Tundra launch lend confidence to the ability of the Detroit 3 to defend this highly-profitable segment. Dodge's new pickup offerings will also include a light-duty diesel product. Continuing double-digit growth in export sales will also provide marginal support to consolidated revenues. Quality issues remain a concern.
The new UAW contract will help Chrysler transition to a more competitive wage and benefit structure over the next several years, although a structural cost Gap will still remain versus the transplants. The most significant cost savings will derive from a reduction in the hourly work force of approximately 30% from December 2006 to December 2008, along with a transition of as much as 20% of the remaining U.S. hourly workforce (Fitch estimate) to lower wage and benefit levels. This could result in a longer-term reduction in consolidated wage and benefit costs by more than a third when factoring in temporary workers. The transition of new hires to defined contribution pension and health care programs also reduces longer-term structural risks. Reductions in the hourly workforce have been accompanied by commensurate reductions in salaried and contract workers. Nevertheless, transplant manufacturers will retain a meaningful cost advantage resulting from platform and parts commonality, flexible manufacturing capability, capital investment efficiency and quality.
The establishment of a VEBA, and the associated transfer of healthcare liabilities represents a significant transfer of medical cost Inflation risk from Chrysler to the UAW. The funding of the VEBA through a combination of existing VEBA funds, wage and Cost of Living Allowance allocation (COLA) transfers, and debt was prudently funded to preserve required operating liquidity at Chrysler. The benefits, which will begin to be realized until 2010, are significant in relation to the upfront funding requirements. Net liquidity, however, may be modestly reduced, during a period of industry uncertainty.
Chrysler's market share has held up relatively well versus Ford and GM over the past seven years, although sales Performance has been habitually boosted through over-production, incentives and higher fleet sales. Relatively moderate declines in market share have resulted from better Performance across a number of product segments, which has aided capacity utilization and resulted in more modest capacity cutbacks than at Ford and GM. (Chrysler currently has one assembly plant scheduled for closure.) As a result, cost reductions should more directly translate into improved Margin and cash flow performance. In a more favorable industry environment then currently projected the combination of Chrysler's product performance and material cost reductions could put Chrysler on a path to positive cash flow. Chrysler's sales outside NAFTA (approximately 8% in 2006) is growing rapidly and could represent an important factor in sustaining capacity utilization if export growth continues at its current pace. Fitch believes the current U.S. dollar weakness could also support further export market gains.
The relationship with Daimler AG (which retains a 19.8% ownership stake in Chrysler) remains an important factor in the rating. Although cost synergies did not materialize to the extent forecasted following the Merger of the two entities, joint programs involving platform consolidation, parts commonality, purchasing initiatives, research and development, etc. remain intact and are expected to result in achievement of variable cost reductions over the longer term. Access to Daimler powertrain, safety, Emission and other technologies provides R&D scale that Chrysler would otherwise lack, and which is critical to remaining globally competitive. In particular, access to Daimler's diesel technology could represent an important competitive advantage as diesel products gain traction in North America, as expected.
Strategically, Chrysler has displayed an 'asset-lite' approach to its expansion plans. Chrysler has demonstrated this approach by contracting out manufacturing of its vehicles in Europe, utilizing its North American capacity to manufacturer non-Chrysler brands, and outsourcing on-site non-assembly operations. Fitch expects that Chrysler will continue to leverage its brands, engineering and design, technologies and products to expand its global presence through joint-ventures, alliances, etc. in a capital efficient manner. Chrysler's joint-venture with China-based Chery, expected to eventually manufacture exports to the U.S., is consistent with this strategy.
Over the intermediate term, legislative and regulatory risks across a wide spectrum of issues are rising, which could lead to changes in consumer demand, cost competitiveness, product standards, investment requirements, etc. Issues include fuel efficiency requirements, emissions standards, safety standards, tax policies and free-trade policies, etc. The majority of which could adversely impact operating performance at Chrysler.
Fitch's rating of 'BB+/RR1' on the first-lien and second-lien portions of the term loan reflects expectations of full recovery in the event of a restructuring event. The loans are secured by substantially all of Chrysler's tangible and intangible assets and is subject to a borrowing base. Fitch's recovery methodology model incorporates a scenario of materially reduced market share and revenues, a continuation of manufacturing operations, and a high level of cash remaining on the balance sheet to finance ongoing working capital obligations. Recovery values, as has been the pattern in the auto parts sector, reflect the substantial savings in wages, benefits, asset rationalization and other fixed costs than can be realized as part of the restructuring process. Fitch views Chrysler's gains in plant efficiency, the core strength of certain product lines, and the value of certain brands (particularly Jeep) and a growing global presence would lead to continued production by these plants, thereby enhancing the emerging Enterprise Value and supplementing recovery values obtained from other working capital and physical assets. Although Chrysler Financial remains a separate legal entity, incentives exist for Cerberus to keep Chrysler capitalized in order to retain the value and viability of Chrysler Financial.