Fitch Affirms United Technologies at 'A'; Outlook Revised to Negative
Fitch Ratings has affirmed the Issuer Default Rating (IDR) for United Technologies Corporation's (NYSE: UTX) at 'A'. The Rating Outlook is revised to Negative from Stable. A detailed rating list follows at the end of this press release.
Key Rating Drivers:
The ratings consider UTC's consistently strong operating performance, competitive market positions, geographic and product diversification, solid free cash flow (FCF), and ability to generate favorable margins through economic cycles. The company made significant changes to its business portfolio during the past year including the acquisition of Goodrich and the purchase of a larger ownership interest in IAE International Aero Engines (IAE) which is now consolidated with UTC's results. These transactions strengthen UTC's presence in its aerospace markets and can be expected to support the company's long-term financial results. It also made a number of divestitures, primarily commercial businesses, which helped fund the acquisitions. As a result, the proportion of commercial and military aerospace business has increased to slightly more than half of UTC's revenue compared to slightly more than 40% previously.
The Negative Rating Outlook reflects UTC's leverage, which remains weak for the ratings while the company reduces debt used to fund last year's acquisitions. The Outlook is centered on the pace of debt reduction and the level at which credit metrics ultimately stabilize. Fitch believes UTC has adequate financial capacity to rebuild credit metrics to strong levels in the near term that would support a rating of at least 'A'. However, the expected improvement in leverage could be less than initially anticipated by Fitch due to conditions in certain of UTC's global markets which continue to face challenges and where recovery has slowed or been delayed. The level at which metrics eventually stabilize will depend on demand in UTC's end-markets as well as the company's allocation of FCF toward debt reduction, internal reinvestment, and discretionary spending for share repurchases and acquisitions.
Debt/EBITDA on a last-12-month basis at March 31, 2013 was 2.6x, well above historical levels of around 1.3x or less, but was somewhat overstated as it does not include the full impact of earnings from Goodrich and IAE. Fitch expects debt/EBITDA to decline to around 2.1x by the end of 2013, slightly above the original estimate of 2.0x, and toward 1.8x by the end of 2014. Actual leverage could be lower if revenue is above the $64 million-$65 million range assumed by Fitch, margins improve more than expected, or debt repayment is greater or occurs sooner than anticipated.
The Rating Outlook could return to Stable if UTC rebuilds credit metrics to stronger levels within the next two years or so. Credit metrics consistent with UTC's current 'A' rating include debt/EBITDA near 1.5x-1.6x or below, and FCF-to-total adjusted debt close to around 20% or higher. Historically, UTC maintained the ratio closer to 25%, but the ratio could be somewhat less in the near term due to investment in development programs and working capital requirements in the aerospace business.
UTC is well-positioned to benefit from long-term growth in commercial aerospace as global passenger traffic increases and airlines increase capacity and upgrade aircraft. The Goodrich acquisition strengthened UTC's already solid position as a supplier of aerospace and defense equipment and services. Also, Pratt & Whitney's (P&W) development of the geared turbofan engine has been successful to date; it has a solid backlog on several new aircraft programs, which helps to address a long-term decline in P&W's market share for large commercial engines. These developments should more than offset pressure in defense aerospace associated with pressure on the U.S. defense budget and a weak European economy. Concerns about military spending are also mitigated by UTC's attractive positions as a key supplier on several military programs for which production is expected to remain stable or ramp up over several years, including the H-60 helicopter, Joint Strike Fighter (JSF), and CH-53K heavy-lift helicopter.
Emerging markets, particularly China, are an important source of long-term growth for UTC. GDP growth in China has declined to a more moderate level, projected by Fitch at 7.5% in 2013 and 2014. China also remains sensitive to government policies and credit availability. In addition, Europe remains weak and commercial construction in the U.S. is still slow despite some recent improvement. These situations are likely to persist and could constrain UTC's overall revenue and margin growth in the near term despite a recent increase in orders in China at the Otis segment and gains in the residential construction market in the U.S.
UTC expects to incur restructuring charges of at least $350 million in 2013, compared to $614 million in 2012, which could support margin improvement in 2013 estimated by Fitch at approximately 80 basis points. Restructuring is spread across all segments but was concentrated in 2012 at Otis; Climate, Controls & Security (CCS); and UTC Aerospace Systems (UTAS). CCS is realigning and integrating the fire and security business, and UTAS continues to integrate Goodrich. UTC estimates cost synergies related to integrating Goodrich could reach approximately $500 million annually by 2016.
Fitch views UTC's estimate of $6 billion of FCF before dividends in 2013 as achievable based on synergies from the Goodrich acquisition, the inclusion of IAE, ongoing restructuring in the CCS segment, and a nascent modest recovery in some of Otis' end-markets. This level of FCF would support the company's plan to reduce debt by at least $2 billion in 2013 in addition to funding dividends and discretionary spending. Fitch expects FCF to increase modestly in 2014 and be maintained at solid levels over the long term. FCF includes the impact of lower pension contributions which UTC estimates will decline to $200 million in 2013 from $430 million in 2012. Additional contributions are possible but not required. At March 31, 2013, U.S. plans were 88% funded. The company suspended share repurchases in 2012 but repurchased $335 million in the first quarter of 2013 and maintains a placeholder of $1 billion for repurchases for the full year. It also budgets $1 billion for acquisitions.
In addition to leverage, rating concerns include risks related to developing new aerospace programs, including Sikorsky's CH-148 helicopter program with the Canadian government which has experienced significant cost overruns and charges, although the program is still expected to be profitable over its life when including aftermarket revenue. Other concerns include competitive pressure, lower defense spending in the U.S., and contingent obligations which include financing commitments and ongoing litigation surrounding P&W's F100 engine. Financing commitments have increased and are likely to increase further, consistent with higher production in UTC's commercial aerospace markets. However, commitments extend over several years, and concerns about potential funding needs are mitigated by the availability of alternative financing to customers and by minimum requirements for interest rates and collateral.
At March 31, 2013 UTC's liquidity included cash and equivalents of approximately $4.8 billion and $4 billion of committed bank facilities that mature in 2016. Liquidity was offset by $1.1 billion of debt due within one year. UTC's outstanding debt totaled $22.8 billion, including $1.1 billion of junior subordinated notes that are part of equity units issued to help fund the Goodrich acquisition. The notes do not receive equity credit from Fitch, since at least some of the notes could remain outstanding until maturity in 2022.
Fitch rates Goodrich's debt at the same level as UTC due to UTC's implied support for Goodrich. UTC has not assumed or guaranteed Goodrich's debt, but Goodrich is important to UTC's aerospace strategy and has been combined with UTC's Hamilton Sundstrand business. UTC has redeemed approximately $800 million principal amount of Goodrich debt since the acquisition, and approximately $1.5 billion of Goodrich debt remains outstanding.
A positive rating action is unlikely in the near term while UTC rebuilds credit metrics following the Goodrich acquisition. The Rating Outlook could return to Stable if UTC rebuilds credit metrics to stronger levels within the next two years or so. Credit metrics consistent with UTC's current 'A' rating include debt/EBITDA near 1.5x-1.6x or below, and FCF-to-total adjusted debt close to a range around 20% or higher.
Fitch could consider a downgrade if credit metrics do not strengthen sufficiently which could occur if cash deployment is directed away from debt reduction, or if financial results are weaker than anticipated. Developments that could impair UTC's financial results include further slowing of economic growth in China and other emerging regions, additional weakening in developed economies, unexpected challenges in fully realizing synergies from integrating Goodrich or restructuring in the CCS segment, negative events in UTC's aerospace markets, and significant delays or cancellations for military programs at P&W and Sikorsky.
Fitch has affirmed the following ratings:
United Technologies Corporation
--IDR at A';
--Senior unsecured bank credit facilities at 'A';
--Senior unsecured notes at 'A';
--Junior unsecured subordinated debt at 'BBB+';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
--IDR at 'A';
--Senior unsecured notes at 'A'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012).
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