Danfoss 'BBB/A-2' Ratings On CreditWatch Negative On Balance Sheet Concerns And Margin Decline Related To COVID-19

  • Danfoss A/S is actively working to preserve its balance sheet in light of its upcoming $3.3 billion acquisition the vast majority of Eaton Corp's hydraulic business, which we now believe will occur between end-2020 and the beginning of 2021.
  • We anticipate that the COVID-19 pandemic will complicate an already challenging operating environment, triggering Danfoss' margin to decrease by at least 150-200 basis points (bps) from 16.2% in 2019. This would cause Danfoss' free operating cash flow (FOCF) to deteriorate to about €240 million in 2020 from about €480 million last year.
  • We are therefore placing on CreditWatch with negative implications our 'BBB/A-2' ratings on Danfoss.
  • The CreditWatch indicates that we could downgrade Danfoss by one notch to 'BBB-' if, over the following 90 days or so, it becomes clear that Danfoss is not able to strengthen its balance sheet such that its funds from operations (FFO) to debt reaches 25% or higher by end-2021. Additionally, profit margins slipping consistently below 14% would result in a downgrade, all else being equal.
MILAN (S&P Global Ratings) March 25, 2020--S&P Global Ratings today took the rating actions listed above. The CreditWatch negative reflects that we expect 2020 will be challenging for Danfoss, due to likely unprecedented harsh industry conditions because of the COVID-19 pandemic.
The severity of the impact is largely unknown at this stage. For now, we envisage a recession scenario in both the EU and the U.S., and only modest global GDP growth of 1.0%-1.5%, versus our expectation of 3.1% in 2019. This could translate into Danfoss' margin shrinking by at least 150-200 basis points (bps) from 16.2% in 2019. If so, Danfoss would likely generate only half as much FOCF in 2020 as it did last year.
The COVID-19 pandemic will likely cause all of Danfoss' performance figures and credit metrics to drop.
We acknowledge the high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak, and we will update our assumptions and estimates as the situation evolves. For the time being, we estimate that Danfoss' sales could drop by 5%-10% to €5.9 billion in 2020 from €6.3 billion in 2019. We anticipate margins will decrease by at least 1.5–2.0 percentage points from 16.2% at end-2019. This could result in FOCF of about €240 million in 2020, down from about €480 million in 2019. Under this scenario, the company's S&P Global Ratings-adjusted FFO-to-debt ratio could dive to 45%-55% at end-2020 from 67% at end-2019.
Danfoss is pushing back with credit-friendly measures to achieve an FFO-to-debt ratio of at least 25% by end-2021 and above 30% from 2022 on.
We understand that the company is rolling out initiatives to preserve earnings and cash flow, and plans to postpone part of its discretionary capital expenditure (capex). In addition, Danfoss is actively seeking permanent funding for its hydraulic business acquisition from Eaton for $3.3 billion. Although the bridge financing is in place, the company strives to secure a final financing pack well ahead closing. We understand that the financing could include equity or equity-like instruments to strengthen the group's balance sheet. Absent such measures, we believe the company's S&P Global Ratings-adjusted FFO-to-debt ratio in 2021 and 2022 would likely be well below 25% and 30%, respectively, which would not be commensurate with the current 'BBB' rating.
The CreditWatch negative indicates that we could downgrade Danfoss by one notch if, over the following 90 days or so, the company is unable to put in place a funding strategy foreseeing equity or equity-like instruments to fund a material part of its planned $3.3 billion acquisition.
We aim to resolve the watch over the next three months or so, once we get additional information on the company's funding strategy.

An adjusted FFO to debt at or above 25% by the end of 2021 and consistently above 30% by the end of 2022 is commensurate with the 'BBB' rating on Danfoss. Failure to meet these levels will likely result in a one-notch downgrade. Furthermore, any major and lasting impacts from the COVID-19 spreading that would lead us to believe Danfoss' profit margins won't be at about 14% in 2020 would likely result in a downgrade, all else being equal.
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