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Fitch Ratings has affirmed the ratings for Jabil Circuit, Inc. (Jabil), including the long-term Issuer Default Rating (IDR) of 'BBB-'. The rating actions affect approximately $3.1 billion of debt, including the company's $1.5 billion revolving credit facility (RCF). The Rating Outlook is Stable. A full list of ratings follows at the end of this press release.
The ratings and Stable Outlook reflect Fitch's expectations that Jabil's operating performance will remain solid through the intermediate term, driven by higher content and strengthened end demand at Jabil's largest customer. A number of new program wins in non-traditional markets that have begun to ramp over the past couple of quarters also should drive solid top-line performance over the medium term.
Fitch expects the growth in non-traditional markets, including wearables and packaging, will drive faster organic growth in the mid-single digits. Fitch expects acquisitions could bolster top-line growth, particularly deals leveraging Jabil's acquisition of Nypro Inc. (Nypro) at the beginning of fiscal 2014, given even greater fragmentation in new markets.
Faster growth in non-traditional end markets will diversify Jabil's revenues, reducing the company's significant exposure to the volatile mobility space. Nonetheless, mobility programs remain significant volume and revenue contributors and Fitch believes Jabil's increasing capabilities and higher share of bill of materials will modestly temper cash flow volatility associated with wireless devices.
Fitch expects operating EBITDA will expand from the mid-single digits through the intermediate term, driven by top-line growth, lower fixed costs from Jabil's restructuring actions in fiscal 2014, and higher profit margins associated with non-traditional markets. Fitch estimates operating EBITDA margins for non-traditional markets are double those for traditional markets, although the agency expects profit margins will remain thin for the rating.
Fitch expects annual free cash flow (FCF) will range from $250 million to $500 million, driven by revenue and profitability growth. Capital spending will remain elevated for at least fiscal 2015 and Jabil recently raised capex guidance to $900 million, which Fitch estimates will translate to FCF on the lower end of Fitch's FCF forecast. Over the longer-term, Fitch anticipates capital spending will return to more normalized levels in the $500 million to $600 million range.
Fitch expects Jabil will use FCF for a combination of acquisitions and share repurchases, although the company generates a substantial amount of FCF overseas.
Jabil has not announced a new share repurchase authorization. However, the agency expects future share repurchases to be used primarily for anti-dilution purposes.
Fitch expects credit protection measures will remain solid and provide Jabil head room for short-term operational shortfalls and incremental debt issuance. Fitch expects total leverage (total debt-to-operating EBITDA) to remain below 2.5x longer-term, versus a Fitch-estimated 1.6x for the latest 12 months (LTM) ended May 31, 2015. Total leverage adjusted for rent expense and off-accounts-receivable sales should remain below 4x and was a Fitch-estimated 2.4x for LTM ended Feb. 28, 2015.
KEY RATING DRIVERS
The ratings are supported by:
- Jabil's scale advantages as one of the largest of the tier 1 EMS vendors with a balanced global manufacturing footprint, including a strong mix of facilities in low-cost regions. Jabil's full suite of increasingly complex EMS product offerings including product design, engineering, and product lifecycle management, which enhance the value of EMS partnerships for customers;
- Favorable industry trends toward increased outsourcing of product design consultation, component sourcing, manufacturing, and fulfillment logistics;
- Jabil's focus on underpenetrated, rapidly growing areas like the industrial, medical, and defence and aerospace verticals. Jabil has a leading position in the emerging industrial, medical, and clean tech space. Customer engagements in these sectors tend to be much deeper with longer product life-cycles and increased opportunity for cross-selling services;
Rating concerns include:
- Significant customer concentration risk with Jabil's top five customers accounting for 51% of revenue for the six months ended Feb. 28, 2015;
- Minimal room for execution missteps, due to the relatively low profit margin inherent in the EMS business model;
- Volatile FCF due to substantial working capital and capital expenditure requirements, although Fitch anticipates an increased sales mix of non-traditional markets provide greater revenue and FCF visibility.
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:
- Revenue mix slowly shifts towards the higher-margin DMS segment. EMS revenue growth will continue to approximate GDP-like levels, with the segment serving as the more stable source of profitability.
- Capital expenditures remain high in 2015 as a result of increased investment in the DMS segment to expand capacity for machining, mobility, healthcare and packaging.
- Fitch anticipates Jabil will maintain its dividend of approximately 32 cents per share. Share repurchases total $40 million in fiscal 2015 and $100 million annually thereafter, consistent with management's guidance.
Positive rating actions could occur if:
- Jabil expands its currently thin operating margins from higher sales in non-traditional markets translating into higher and more consistent annual FCF of more than $500 million;
- Fitch's expectations for structurally lower leverage through the cycle (total adjusted leverage near 2.5x).
Future developments that may, individually or collectively, lead to negative rating action include:
- Expectations for sustained total leverage above 3x, likely due to margin compression following loss of significant customer(s) or secular shifts. The current ratings incorporate expectations for short-term margin volatility but also assume visibility with respect to profit margins recovering to historical levels in the near term.
- A lack of further end market diversification over the longer term, leaving the company susceptible to significant operational shortfalls from lower than expected volumes for a limited number of products;
- The inability to generate positive annual FCF through the cycle.
Fitch believes liquidity as of May 31, 2015 was solid and consisted of:
- $963 million of cash (cash located overseas and subject to taxes on repatriation were not disclosed on third-quarter 2015 earnings release, but totalled $771 million at Feb. 28, 2015);
- Full $1.5 billion availability under Jabil's senior unsecured RCF expiring July 2019.
Jabil also uses two accounts receivable securitization facilities for additional liquidity purposes, both of which are located off balance sheet: a $175 million committed European receivables facility and a $200 million committed North American receivables securitization which were was set to expire in May 15, 2018 and Oct. 20, 2017, respectively.
Fitch's expectations for $250 million to $500 million of annual FCF through the intermediate term also support liquidity.
Total debt as of May 31, 2015 was approximately $1.6 billion and consisted of:
- $312 million in 7.75% senior unsecured notes due July 2016;
- $400 million in 8.25% senior unsecured notes due March 2018;
- $400 million in 5.625% senior unsecured notes due Dec. 2020; and
- $500 million in 4.7% senior unsecured notes due July 2022.
Fitch affirms the following ratings:
- Long-term IDR at 'BBB-';
- Senior unsecured RCF at 'BBB-';
- Senior unsecured debt at 'BBB-'.