Fitch Ratings Assigns 'BB+' To Cummins Engine Company, Inc.

    CHICAGO--March 21, 2002--Fitch Ratings has assigned a rating of 'BB+' to the senior unsecured debt of Cummins Engine Company, Inc. (Cummins), and a rating of 'BB-' to the company's mandatorily redeemable convertible preferred securities. The ratings are based on the company's steady and significant decline in market share in its key heavy-duty and medium-duty engine markets, and uncertainty as to the company's scale and capacity to commit the capital necessary to stay competitive in its markets over the long term. The recent steep cyclical decline in the heavy-duty truck market has further impacted cash generation and required the company to obtain external financing. Recent financing transactions have raised leverage and fixed charge obligations, and recovery in financial ratios to previous levels is not expected over the near term. The company also faces pending maturities in 2003 that include a $125 million note issuance and the company's $500 million bank agreement. Refinancing will likely result in higher costs and more stringent credit terms, and the potential exists for the bank group to seek a secured position as part of any new agreement. The Rating Outlook is Negative.
    Cummins has experienced a consistent and meaningful drop in market share over the past several years, with its share of the heavy-duty truck market falling from 38% in 1996 to 24% in 2001. Together with the downturn in the heavy-duty truck market, this has resulted in a 47% decline in unit deliveries in this segment over that period. In the medium duty engine segment, market share has fallen from 39% in 1996 to 13% in 2000. Although Cummins offers a technologically competitive product line, consolidation and vertical integration among its customers have placed the company in competition with its major customers' in-house suppliers. Major customers include DaimlerChrysler and Volvo, which through their purchases of DaimlerChrysler and Mack, respectively, can be expected to increasingly turn to in-house truck engine sourcing over the intermediate term. It should be noted that Cummins has recently signed long-term supply agreements with both of these firms, although the volume and margin impact are uncertain.
    The recent steep decline in the heavy-duty truck market resulted in part from a heavy jump in production at DaimlerChrysler's Freightliner unit in the late 1990's, in an effort to gain market share. Along with guaranteed buyback provisions, the jump in production levels has produced a glut of used trucks in the market and suppressed demand for new vehicles, a situation likely to persist through 2002. DaimlerChrysler accounted for approximately 14% of Cummins' sales in 2001, 19% in 2000 and 19% in 1999, representing a decline in dollar sales from $1.3 billion in 1999 to $0.7 billion in 2001. Fitch's view is that production at Freightliner is not likely to reach production bubble levels of 1999 over the near term, and that over the long term, DaimlerChrysler will source a greater share of its engine requirements internally, representing a permanent loss of volume for Cummins.
    Weak operating profitability and numerous charges over the past several years have led to a deterioration in the company's balance sheet, despite relatively flat adjusted debt levels. (Adjusted debt includes the company's mandatorily redeemable convertible preferred securities; receivables securitization and off-balance sheet lease obligations.) Adjusted debt-to-capital has increased from 55% in 1999 to 63% in 2001, due primarily to a decline in the company's book equity from $1.4 billion to $1.0 billion. EBITDA/Interest has declined from over 8 times (x) in 1999, to just over 3x in 2001. On-balance sheet leverage was relatively flat in 2001, although aided by $163 million in asset sales (including $143 million in sale/leaseback transactions) and working capital runoff of approximately $100 million related to the decline in operating results. Cash leverage measures are expected to continue to deteriorate, despite the company's clear progress in lowering its cost structure.
    Cash generation has been weak over the past several years, and is unlikely to improve in the short term due to weakness across the company's end markets. Cummins is also a participant in a number of joint ventures that continue to absorb cash. The financial condition of Consolidated Diesel, a joint-venture that supplies engines to Cummins and accounts for approximately 10% of the company's cost of goods sold, is uncertain. Frequent write-offs provide uncertainty as to the value and efficiency of the company's asset base, particularly as the company loses volume over which to absorb fixed costs.
    Maturities in 2003 include the company's $500 million unsecured bank agreement (fully available as of 12/31/01) and a $125 million note issue. Additionally, the recent sale/leaseback transaction, the company's receivables facility ($55 million outstanding at 12/31/01) and certain dealer financing programs all contain debt-rating triggers that could force the company to draw on the revolver. Cummins has more than sufficient capacity under the revolver to absorb the current level of potential trigger-related requirements. However, the company's weak operating performance and the combination of maturities in 2003 are likely to result in any refinancing being available only at a higher price and under more stringent terms, further escalating financial obligations. Under this scenario, it is not unlikely that the banks would seek to place themselves in a secured position, further impairing unsecured debtholders.
    This rating was initiated by Fitch Ratings as a service to users of its ratings. The rating is based primarily on public information.