Future of Nortek a Question
Melrose plc, parent company to Nortek, Inc., has taken some serious incoming hits this month – hits from both major credit rating agencies Fitch Ratings and Moody’s Investors Service. And these hits hurt. Fitch was first when they announced a couple of weeks ago that in a review of GKN Holdings Limited – Melrose’s largest holding by far – it was maintaining its credit rating at current levels, but it was changing its future “Outlook” to “Negative.” Today, Moody’s announced they too were changing their outlook on GKN from “Ratings Under Review” to “Negative.”
See why credit pros are downgrading the mighty Melrose bet on GKN…
So what exactly do these credit agency moves mean? I mean, how bad can things be if both agencies maintained current credit ratings, but downgraded GKN’s future outlook? Well, the announcement of actions such as this are largely viewed as a warning shot to bond buyers when credit agencies turn negative on a company’s future.
Keep in mind, GKN’s current rating by both agencies is hardly stellar. Fitch rates GKN debt with an IDR (Issuer Default Rate) of BB+. In Fitch-speak, a BB+ rating means that the bonds for that issuer should be considered “speculative” – translation, NOT investment grade stuff.
BB’ ratings indicate an elevated vulnerability to default risk, particularly in the event of adverse changes in business or economic conditions over time; however, business or financial flexibility exists that supports the servicing of financial commitments.”
Fitch Ratings, Ratings Definition
Junk Bonds – ‘Substantial Credit Risk’
Similarly, Moody’s rates GKN debt as Ba1. Here’s how Moody’s defines that rating: “Obligations rated Ba are judged to be speculative and are subject to substantial credit risk.” You may be familiar with a term bond buyers like to sling at below investment grade issuer debt described as speculative…they are known colloquially as “junk bonds.”
Melrose is deeply invested in GKN, which is a large automotive and aerospace engineering company in the UK. They paid an ambitious $11 billion when they acquired the company in March 2018, almost two years after acquiring Nortek. GKN was by far Melrose’s largest acquisition. Did it bite off more than it can chew?
A Big Bite Leading to Signs of Stress
This was certainly a big bite for them and widely reported (by the U.K. media anyway) signs of stress began to appear almost immediately. Just a few months ago, Strata-gee reported on actions that Melrose was taking to cut expenses, such as dropping dividend payments and cutting executive pay 20%. GKN is one of the largest companies in the U.K. and Melrose definitely benefited from a real boost in their revenues. But the large and diverse GKN stressed Melrose’s resources…both financially and in terms of management.
“The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The global automotive and aerospace industries are among the sectors that are most severely impacted…”
Moody’s Investors Service, Rating Action Announcement
In 2018, Execs Leaked to Media Company is Considering Selling Nortek
Then, in October of 2018, Melrose executives began leaking to the media that they were considering selling off their Nortek division. Although they tried to spin it by saying this idea was largely to harvest their gains in Nortek…it ultimately emerged that Melrose management was stretched thin. Not mentioned, but clearly part of the equation, was that they also needed to raise cash to help with the challenging GKN turnaround – problems with GKN led Melrose to realize a net loss of £150 million (about $195 million).
Then, in January of this year, Strata-gee reported that once again Melrose was considering selling off Nortek. In fact, as I suggested in the headline, “This Time It’s Serious,” as the company actually hired advisory firms to help in the process of selling Nortek. However, this decision may have come too late, because before they could pull it off, COVID-19 hit the world hard.
The Future of GKN…Melrose…and Nortek Looks Cloudy
Now, the credit agencies suggest the future for GKN…and hence, Melrose…and hence, Nortek…is cloudy. Here are some of the comments associated with this outlook downgrade from Fitch and Moody’s.
- Fitch Ratings
- “The Negative Outlook reflects the likelihood that the effects of the coronavirus pandemic could materially hinder or delay the previously expected recovery in cash generation and leverage to levels consistent with a “BB+” rating. “
- “It also reflects the risk of a protracted weakened economic environment and its potential effect on new vehicles and aircraft production.”
- “Fitch expects global vehicle production to fall about 20% and production of several civil aircraft programmes to fall 25%-35% in 2020… The fall in revenue will strongly impair fixed-cost absorption with a material effect on profitability.”
- “Our rating case includes a decline of about 50% of EBITDA and funds flow from operations… “
- Moody’s Investors Service
- “The change of outlook to negative from ratings under review reflects the severe pressure on Melrose’s financial performance, GKN’s parent and guarantor of the bonds, primarily as a result of the downturn in the automotive and aerospace end markets that account for the vast majority of GKN and Melrose’s operations.”
- “Moody’s expects a meaningful double-digit decline of revenue as well as a substantial deterioration of profits for 2020 followed by some recovery, although the weaker demand in the aerospace segment is likely to persist well beyond 2020.”
- “As a result, key financial metrics such as margin and leverage will likely fall outside of the range for the Ba1 instrument ratings in 2020 and Moody’s-adjusted debt/EBITDA appears unlikely to return to levels commensurate with the Ba1 instrument ratings before 2022.”
- “Accordingly, the bond ratings are now weakly positioned and the ability to restore metrics is subject to execution risks as well as further end market developments.”
Both Agencies Hint at Further Ratings Downgrades
Interestingly, both Fitch and Moody’s make sure to suggest that the current credit rating may have to change in the future. Fitch: “…the coronavirus pandemic could materially hinder or delay the previously expected recovery in cash generation and leverage to levels consistent with a ‘BB+’ rating.” Moody’s: “As a result, key financial metrics such as margin and leverage will likely fall outside of the range for the Ba1 instrument ratings…”
This is another warning of a further downgrading for GKN AND Melrose, who is the guarantor of all GKN debt. More pressure on Melrose will likely raise the pressure level on all of their holdings…including the struggling Nortek.
You can learn more about Melrose by visiting: melroseplc.net.
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