Fitch Ratings has affirmed International Rectifier Corp.'s (IR) (NYSE: IRF) Issuer Default Rating (IDR) at 'BB'. The company currently has no outstanding public debt or bank credit facility. The Rating Outlook is Stable.
Despite current end market demand headwinds, Fitch believes the company's long-term organic revenue growth prospects remain solid, driven by increasing power management penetration. After 31.4% top line growth for the fiscal year ended June 30, 2011, Fitch anticipates revenues will decline in the high single to low double digits in fiscal 2012.
General weakness throughout Europe across all end markets, an ongoing indirect channel inventory correction, and soft demand for computers and appliances markets will more than offset modest strength in high-reliability productions for commercial aerospace markets and rapid adoption of high-performance servers. Nonetheless, the supply chain is closer to achieving more normalized inventory levels, which Fitch believes drive could result in positive sequential revenue growth for IR in the first half of calendar year 2012.
Weakened demand and inventory correction, as well as buffer inventory added in anticipation of the company's enterprise resource planning (ERP) system implementation should constrain factory utilization rates to less than optimal levels for the year. Utilization rates in the mid 90s exiting fiscal 2011 will remain in the 70s and below level for the current quarter, which will be a drag on gross margins. Still Fitch anticipates gross margins will remain at or above 35% for the year and range from 35% to 40% through the intermediate term.
Fitch estimates free cash flow will be flat to modestly negative for fiscal 2012, driven by lower profitability and higher investments associated with the ERP system implementation. Nonetheless, the ERP investment should drive profit margin expansion beyond fiscal 2012. Capital spending levels should return to the company's longer-term target of 10% of revenues or below. In conjunction with planned manufacturing facilities consolidation, free cash flow should remain modestly positive through fiscal 2014.
The rating and Outlook continue to be supported by IR's: i) technology leadership and resultant leading share in a number of power management markets; ii) addressable market growth driven by long-term secular trends of increased electronics content and demand for energy efficiency; and iii) meaningful customer and geographic diversification, including a strong presence in China and other faster growth regions.
Ratings concerns continue to center on the company's: i) volatile historical free cash flow; ii) substantial structural investments in research and development (R&D) and capital spending; and iii); small revenue base in its sole focus on the discrete power management market, which includes several participants with greater scale and financial flexibility.
Fitch believes positive rating actions could result over the intermediate term from more consistently positive annual free cash flow, likely from solid organic revenue growth and structurally lower investment requirements, which Fitch believes could be achieved through increased outsourcing.
Negative rating actions could result from:
--Lower than industry-level top-line growth, suggesting a weakening of the company's technology leadership position.
--Consistently negative free cash flow likely driven by sustained profitability erosion or meaningfully higher investment levels to counter competitive pressures.
As of Dec. 31, 2011, Fitch believes IR's liquidity was sufficient and supported by nearly $386.8 million of cash, cash equivalents and short-term investments. IR has no revolving credit facility. Fitch expects annual free cash flow to range from slightly negative to modestly positive over the intermediate term, driven by the company's small revenue base and relatively fixed investment requirements. The company has no public debt and Fitch has no expectations for near-term debt issuance. Nonetheless, depending upon uses of proceeds, Fitch believes IR can issue debt in line with historical amounts of approximately $500 million-$750 million without negatively affecting the IDR or outlook. This would equate to total leverage (total debt to operating EBITDA) of 3x-4x.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Rating Global Technology Companies Sector Credit Factors' (Sept. 20, 2010).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Rating Global Technology Companies - Specific Rating Factors
70 West Madison St.
Chicago, IL 60602
John Witt, CFA
James Rizzo, CFA
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