Is Moody's Liquidity Rating Downgrade for ADT Bearish?

Moody's Investor Service downgraded The ADT Corporation's ADT speculative-grade liquidity rating by one notch to SGL-2 from SGL-1. The credit rating agency cited weaker cash balances and higher borrowings as reasons for the downgrade.

Rationale behind Downgrade

The downgrade of the company's liquidity rating was primarily attributable to higher borrowings under its revolving credit facility and a lower covenant cushion. Also, ADT's recent acquisition of Reliance Protectron, Inc. lowered its cash balances, further impacting its liquidity. Since Jan 2014, the company has increased its quarterly dividend by 60% to 20 cents per share, and is thus employing incremental cash for meeting its dividend payment needs.

The company has strong free cash flow generation prospects and has access to undrawn balances under its revolving credit facility as well. However, since its spin-off from diversified conglomerate Tyco International Ltd. TYC in Sep 2012, the company has introduced new share repurchase programs and expansion strategies, thus changing its leverage targets often. The company's volatile financial policy and aggressive leverage targets create some degree of uncertainty in its strategic risk levels.

Ratings Outlook

ADT's liquidity ratings could be further downgraded if its debt levels increase without a corresponding boost in earnings. Additionally, higher attrition rates or deteriorating liquidity could impact the ratings negatively as well.

The company's ratings could receive an upgrade if it leans towards more conservative financial policies and sustains lower debt levels.

ADT's Prospects

ADT is a leading provider of electronic security, interactive automation, and monitoring services, and is a leader in the high-potential residential-alarm-monitoring space in North America with about a 25% market share. The company has displayed strong focus on growth, complementing organic growth strategies with accretive acquisitions.

ADT's subscription-based business model enables high margins in the monitoring business. Moreover, the company consistently focuses on innovation to keep up with the dynamic market environment. This Zacks Rank #2 (Buy) firm has also partnered with Ford Motor Co. F to combine Ford's SYNC technology with its Pulse technology. This technology will allow users to control the security of their house using voice commands while on the road.

However, ADT faces increasing competition from non-traditional security service providers. Some cable and telecom companies are launching interactive security services that compete with ADT's offerings. Also, Google Inc. (GOOGL) has ventured into this arena by acquiring connected device company Nest Labs.

The company has aggressive expansion plans for the future as it leverages its competitive positions and explores new growth opportunities. Its strategies will likely lead to higher leverage as well. However, it is too early to predict whether the liquidity rating downgrade will have a negative impact on investors or not.

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