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Rating Action:

Moody's changes Arconic Inc.'s outlook to negative; affirms Ba2 CFR

24 Jan 2020

Approximately $6.0 billion of rated debt affected

New York, January 24, 2020 -- Moody's Investors Service, ("Moody's") changed Arconic Inc.'s ("Arconic," or the "Company") rating outlook to negative from stable. Concurrently, Moody's affirmed the company's Ba2 Corporate Family Rating ("CFR"), Ba2-PD Probability of Default rating and Ba2 senior unsecured notes rating following the Company's announcement of its debt raise as part the separation (the "Separation") of its global rolled products business segment (Arconic Rolled Products Corporation, to be renamed "Arconic Corporation"), expected to close in the second quarter of 2020. At the time of Separation, Arconic Inc. will be renamed Howmet Aerospace. In addition, Arconic's Speculative Grade Liquidity ("SGL") rating was upgraded to SGL-1, reflecting the expectation of a very good liquidity profile over the next twelve months.

The change in outlook to negative was driven by uncertainty surrounding Arconic's ability to de-lever from peak level debt/EBITDA of close to 4x on completion of the Separation to financial leverage more commensurate with a Ba2 rating over the next 12 months. This uncertainty is driven by lack of clarity with respect to future financial policy and related capital allocation, as well as ambiguity regarding the duration of the production halt of 737 MAX production at The Boeing Company ("Boeing") and Spirit Aerosystems, Inc. ("Spirit"), to which Arconic is a key supplier.

The company's SGL rating was upgraded to SGL-1 from SGL-2 largely due to the expectation that the company will maintain a sizable undrawn revolving credit facility, ample cash balances and free cash flow generation exceeding $500 million annually.

"Although the company's operating and free cash flow profile have improved meaningfully over the past year, aggressive share repurchase activity and uncertain future financial policy underlie our view of the company's credit profile" said Gigi Adamo, Moody's Vice-President, Senior Analyst.

"However," Adamo added, "the greater long-term visibility in the company's revenue stream from the higher margin aerospace & defense business that will comprise a majority of revenues post separation relative to the more cyclical global rolled products business is a positive credit consideration."

Upgrades:

..Issuer: Arconic Inc.

.... Speculative Grade Liquidity Rating, Upgraded to SGL-1 from SGL-2

Affirmations:

..Issuer: Arconic Inc.

.... Corporate Family Rating, Affirmed Ba2

.... Probability of Default Rating, Affirmed Ba2-PD

....Pref. Stock Preferred Stock, Affirmed B1 (LGD6)

....Senior Unsecured Regular Bond/Debenture, Affirmed Ba2 (LGD4)

..Issuer: Iowa Finance Authority

....Senior Unsecured Revenue Bonds, Affirmed Ba2 (LGD4)

Outlook Actions:

..Issuer: Arconic Inc.

....Outlook, Changed To Negative From Stable

RATINGS RATIONALE

Arconic's Ba2 CFR reflects the company's considerable scale, lead market positions in the industries in which it competes, and favorable long term trends in these industries despite near term challenges in the automotive and commercial aerospace sectors. Although the company's sales base will be reduced by about one-half with the Separation, Arconic will generate revenue of approximately $7 billion annually, which is larger than typical among peers at this rating. The company maintains #1 and #2 market positions in many of its product offerings, and has long-standing relationships with aerospace & defense and commercial vehicle OEM customers, with significant presence on key aerospace program platforms. The trend towards light-weighting and increased fuel efficiency are also positive long-term credit considerations. Furthermore, the company has been able to achieve meaningful increases in both profitability and free cash flow generation during 2019. This supports Moody's expectations for EBITDA margins exceeding 20% and at least $500 million of free cash flow annually over the next few years.

At the same time, the Ba2 CFR also considers Arconic's elevated financial leverage as the company undergoes a material transition in its operating profile and capital structure while it completes the separation of its global rolled products business amidst a highly uncertain commercial aerospace environment. Moody's estimates debt/EBITDA of 3.8x on completion of the separation, which is equivalent to the company's leverage as of the last twelve months ended September 30, 2019. Although the company's free cash flow provides the potential for material debt repayment, we expect that the company will prioritize the allocation of free cash flow towards share repurchases over debt repayment reduction, indicating an aggressive financial policy. Moreover, Moody's believes that, if the Boeing and Spirit production halts continue through the first half of the year, debt/EBITDA will likely remain elevated at the 4.0x range in 2020 through 2021, and only moderately improving thereafter. Arconic's sizable pension obligation is also a factor contributing to the company's elevated financial leverage profile.

Corporate Governance and related financial policy is an important tempering consideration in this rating action. Since the company's separation from Alcoa Inc. in November 2016, CEO transition risk has been a credit challenge with Arconic's current Chairman and CEO, John Plant, representing its fourth CEO. Further, it is not yet known who will be the CEO for Arconic (to be renamed Howmet Aerospace) post separation. Additionally, Moody's views the marked increase in cash deployed towards share repurchases as a shift in Arconic's financial policy prioritizing shareholder returns in favor of more aggressive debt reduction. Moody's also notes that activist shareholder, Elliott management remains the company's largest shareholder with an over 11% shareholding and has representation on the Board with one board seat and other members that have been nominated by Elliott.

Beyond governance, environment and social considerations have also been factored into the ratings. On the environmental front, the company's more sizable ongoing and meaningful environmental liabilities are expected to be transferred to the entity to be spun-off, Arconic Corporation. These more meaningful liabilities include those related to the 2017 Grenfell Tower fire in London in 2017 and the ongoing Massena River liability. Although costs to date have not been meaningful, the risk of higher costs going forward have been a ratings consideration. Social risk considerations include the lower cost flexibility and related sizable pension arising from the portion of the company's workforce that is expected to continue to be unionized.

Arconic's SGL-1 rating is characterized by the expectation of free cash flow (including Moody's standard adjustments) exceeding $500 million annually, cash balances remaining above $600 million and ample availability under its unsecured revolving credit facility. Future free cash flow generation is expected to be driven by EBITDA margins continuing to exceed 20%, maintenance of operating and working capital efficiencies attained over the last year and capital expenditures at roughly 4% of sales.

The ratings could be downgraded if Arconic is unable to successfully execute on the Separation or cash outflows related to the Separation are greater than anticipated or if margins deteriorate. In addition, debt/EBITDA that remains above 4.0x, debt-financed share repurchases or dividends and acquisitions or spin-offs that further elevate financial leverage could also pressure ratings downward. Less than 2% organic revenue growth, an erosion in margins and annual free cash flow falling below $450 million annually could also lead to ratings pressure.

The ratings could be upgraded if the company's top line grows organically through positive end-market fundamentals, debt/EBITDA trends towards a sustainable 3.0x level, FCF/debt consistently exceeds 10% and the company maintains a good liquidity profile. The company's ability successfully execute on its cost reduction actions including a meaningful improvement in operating margins to above 11.5% would also be considered.

Headquartered in Pittsburgh, Pennsylvania, Arconic is a major global player in the lightweight metals and high performance multi-materials sector that serves diverse end-markets including aerospace, automotive, building and construction, industrial and commercial transportation end-markets. Approximately two-thirds of the company's revenues are derived from the aerospace, automotive and commercial transportation end-markets. Sales for the LTM period September 30, 2019 totaled $14.3 billion. Pro forma for the pending separation of the company's Global Rolled Products business, revenues approximate $7 billion with over 70% of revenues derives from the aerospace & defense end-market.

The principal methodology used in these ratings was Aerospace and Defense Industry published in March 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Jadijhe (Gigi) Adamo
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Russell Solomon
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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