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Fitch Lowers Delphi Ratings to BBB-, Outlook Negative"
CHICAGO -- Reflecting expectations that operating cash flow will be further constrained at a time when cash requirements -- namely required pension contributions -- are escalating, Fitch Ratings has downgraded Delphi Corp.'s to a negative outlook, officials announced earlier today. Ratings are as follows: Senior unsecured rating to BBB- from BBBTrust preferred rating to BB+ from BBB- Commercial paper rating to F3 from F2The Rating Outlook is NegativeThe cash flow restraint has increased the risk of negative cash flow and higher net debt levels, despite currently healthy liquidity, officials said. Fitch's concerns include Delphi's heavy dependence on General Motors' production volume, significant operating leverage to GM volumes due to a high fixed-cost structure, constrained operating margins resulting from the continuance of significant commodity price pressures and original equipment manufacturer pricing pressure, still onerous legacy costs, the potential risk of additional launch cost issues as seen in the third quarter of 2004, and heavy spending for technology development.Strengths include strong growth in non-GM business, a healthy proportion of high technology products, strong cash balances, and moderate debt levels. Over the intermediate term, an easing of commodity costs, an improvement in GM's competitive position, continued growth in Delphi's non-GM business, a closing of the pension gap, and meaningful progress addressing Automotive Holdings Group losses could lead to a review of the Rating Outlook. Although leverage to GM is steadily decreasing each quarter and is on track to breech the 50% level in 2005, exposure to GM remains a concern, Fitch officials said. As inventories remain at historically high levels after second-half 2004 production cuts, GM's relatively dated product portfolio and Delphi's operating leverage to GM volumes pose incremental risk for 2005 cash flow expectations. Consumers have become somewhat desensitized to GM's substantial incentive packages, as evidenced by disappointing sales in recent months, increasing the risk of further production cuts. Although incentives have helped maintain volumes during the recent economic downturn, this may result in a reduced volume rebound as a result of any improvement in economic conditions. In addition, while GM's new product launches have been passenger cars, a product area that has sorely needed updating, trucks have accounted for the larger portion of GM's production. However, GM's trucks are now becoming dated in the marketplace, and Dodge and Ford have recently introduced new pickups and truck-based sport utility vehicles.While the truck market has traditionally been the bastion of Detroit automakers, new entrants from foreign competition like Nissan's Titan pickup and a significantly redesigned Toyota Tundra due in 2006 could cause erosion of GM's truck market share prior to the introduction of new truck products in 2007 and 2008, leading to additional volume pressure for Delphi. Delphi's top-line growth in non-GM business has been exceptional, indicating strong customer acceptance and technology strengths. Continued progress along this trend line should provide Delphi with the flexibility to address its fixed-cost structure and unprofitable business segments, Fitch officials said.High required pension contributions, currently projected to peak in 2006 at approximately $1 billion, could absorb the large majority of Delphi's cash flow given expected margin pressures, officials said. Delphi's pension plan ended 2003 only slightly better off than it began, despite its impressive 20% asset returns. Since long-term interest rates have actually declined in the face of an improving economy and five Federal Reserve short-term rate hikes, Delphi's discount rate may have to be further ratcheted down, widening its underfunded position. However, over the intermediate term, a likely increase in long-term interest rates will reduce the underfunded position. In the area of other post-retirement employee benefits or health care, Delphi continues to face long-term challenges with an approximate $9 billion unfunded obligation. However, near-term requirements are minimal as Delphi has only 0.25 retirees per active employee and in 2003, paid only $120 million in benefit costs under this pay-as-you-go system. Fitch expects commodity price pressures to remain high in 2005, especially steel costs, and to some degree the cost of petroleum-based raw materials like plastic resins. Margins will continue to be squeezed as the full impact of recent cost escalations work their way into supply contracts. Additionally, Delphi is exposed to commodity price pressures and supply issues among its suppliers. Delphi's legacy cost structure remains a key concern, as demonstrated by the announcement of a slower-than-anticipated U.S. work force attrition rate, another headcount reduction program totaling 8,500 (4.6% of its total work force) and the addition of three facilities to its Automotive Holdings Group. Fitch recognizes the long-term positive impact of steps taken to improve manufacturing efficiency and reduce headcount, but these issues have been and will continue to be addressed at only a moderate pace due to constraints from United Auto Worker labor contracts. Meanwhile, addressing its legacy cost structure has resulted in continued claims on operating cash flows (2005 restructuring charges of $150 million in after-tax cash) at a time when other cash requirements are rising. Launch cost issues, as seen in Delphi's third quarter ended Sept. 30, are standard for automotive suppliers, particularly when a supplier has garnered as much new business as Delphi has with non-GM customers. It appears as though Delphi was unable to recoup incremental launch costs from its customers, which may indicate that Delphi had internal difficulty managing its third quarter launch issues. Over time, Delphi will need to manage its new program launches more smoothly than was in seen in the third quarter."