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The eBearing News
October 13, 2003
Moody's Downgrades Timken Debt,
Company Responds Publicly
copyright © 2003 eBearing Inc.
The Timken Company (USA) had a major setback on Wall Street and in its fight to convince
investors it is moving in the right direction after the Torrington acquisition.
Moody's Investors Service downgraded Timken's senior unsecured debt to Ba1 or "junk" status.
It had previously rated Baa3, the lowest investment grade and only one small step above junk.
The difference, however, is extremely important in financial circles. It is also the first time
in the company's history that its debt has been rated below investment grade.
In mid-September, Moody's and Standard & Poor's both revealed the company's debt rating
was under review in the wake of Timken's latest downward earnings revision.
• article: Timken slashes earnings outlook, debt comes under review
Moody's is one of several services (Standard and Poor's, Fitch, and Duff & Phelps are others) rating
the investment quality of various types of debt. Put simply, Moody's rates corporate debt quality
based on historical information about similarly situated companies and their likelihood of default.
Moody's has 23 levels of long-term corporate bond ratings, running in order from highest to lowest:
| AAA | | | Highest Rating |
| Aa1 | Aa2 | Aa3 | Very High Quality |
| A1 | A2 | A3 | High Quality |
| Baa1 | Baa2 | Baa3 | Minimum Investment Grade |
| Ba1 | Ba2 | Ba3 | Low Grade |
| B1 | B2 | B3 | Very Speculative |
| Caa1 | Caa2 | Caa3 | Substantial Risk |
| Ca1 | Ca2 | Ca3 | Very Poor Quality |
| C | | | In Default |
The single-step downgrade, from Baa3 to Ba1, was all it took to move Timken's debt rating from
"Investment Grade" to "Below Investment Grade" or "junk bond" status.
At the same time, Moody's also lowered Timken's short-term debt rating to "Not Prime" from "Prime-3." The
short-term debt rating system is similar to the above used for long-term debt.
The effects these credit downgrades vary from one company to another. Generally, lower ratings
mean increased costs of capital ... a company has to offer more incentive for investors to buy its debt.
In addition, loan agreements and/or funds available often depend upon a company maintaining
a specific minimum credit rating. In a worst-case scenario, credit downgrades can
trigger loan covenants which require paying down debt, creating a domino effect which can ripple
through a company's finances, drain cash flow and liquidity, and cause other situations to develop.
While Timken has none of those potential problems, it is facing higher borrowing costs due to the downgrade.
Standard & Poor's Ratings Service has Timken under CreditWatch, but so far has kept the
company's debt rating at BBB-, the equivalent to Moody's Baa3. In an earlier statement, Standard & Poor's
said, "there is limited room at the current ratings and outlook" and that key assumptions are that
Timken hits at least the low end of its earnings guidance from now on.
Moody's followed with an, "outlook on all ratings is negative," indicating it is keeping Timken
under close review for another downgrade. It explained, "The negative outlook on Timken's
ratings reflects Moody's concerns that Timken's debt reduction for 2003 could fall short of its objectives,"
citing weakening gross cash flows from the combined Timken and Torrington operations. If Timken cannot
hit its debt reduction targets, Moody's said, "the increased pressure on covenant compliance
would likely result in a review of the rating."
Moody's cited a myriad of other concerns, ranging from questions about how the integration of
Torrington is proceeding for near-term synergies, the loss of Karl Kimmerling as head of Automotive,
market challenges from
imported bearings, rising variable costs in the steel business, and other strategic issues.
Ominously, Moody's said the rating could be downgraded again, "should operating performance deviate
further from its revised expectations." Standard & Poor's also echoed this sentiment
in its earlier statement. One analyst explained these caveats
reflect Wall Street's open frustration with Timken management's credibility in the wake
of two large downward revisions and failure to hit its own first-quarter or second-quarter estimates.
Timken began the year predicting earnings would be as high as $1.25 per share. In its second
downward revision, Timken recently said earnings now could be as low as $0.45 per share. During the
contentious second quarter
2003 earnings call, one analyst openly challenged Timken management that they must have known the company
would miss even the revised earnings estimates, but chose to make no announcement.
Conversely, Moody's said Timken's rating might be revised upward if it was able to reduce
debt, improve operating income and cash flow, reduce fixed overhead, or better combine
Torrington's value-added services to the Timken line, among other possibilities.
In response to Moody's downgrade, Timken issued a press release, finding fault with and challenging
the Moody's analysis. Such public rebukes are somewhat uncommon because, as one analyst told
eBearing, "Often, a company succeeds only in drawing unbalanced attention to those very
issues troubling it the most." Similarly, said the analyst, such public responses often
reflect a company's growing frustration with and/or deteriorating relationship with Wall Street.
Timken President and CEO, Jim Griffith, said, "We are obviously disappointed in the decision made
by Moody's to lower our debt rating. While on September 18 we lowered our earnings outlook for 2003,
we believe Moody's gave insufficient weight to our commitment to maintain a strong balance sheet.
The impact of reduced earnings on cash flow has been offset by other actions, including improving
working capital management, reducing capital expenditures and continuing asset dispositions."
Timken said the impact of the lower rating on the company's future earnings will be minimal, with
only a slight increase in the cost of capital.
The company went on to reiterate its September 18 position that earnings have been challenged by
declines in North American automotive production, resulting inefficiencies in the automotive
parts production facilities, increased energy and raw materials costs in its steel business,
and continued weak industrial markets.
Mr. Griffith said, "We believe that the acquisition of The Torrington Company, earlier this year, is a strong
strategic move that positions Timken for long-term competitiveness. The issues we are facing with regard to our
2003 earnings are short-term, and corrective actions are being taken. We continue to be committed to a strong
balance sheet and will aggressively apply discretionary cash to debt reduction."
Timken's third quarter 2003 financial results are due to be reported on October 23, 2003.
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- by Bruce A. Carr
from individual research,
tips and commercial sources.
Bruce Carr edited this content.
Copyrighted material; unauthorized reproduction prohibited.
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Entire contents Copyright © 1999-2011, eBearing Inc. All rights reserved.
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