NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) and long-term debt ratings for Textron Inc. (TXT) and Textron Financial Corporation (TFC) at 'BBB-'. The Rating Outlooks are Stable. TXT's short-term ratings have been affirmed at 'F3'. A full rating list follows at the end of this release.
TXT announced yesterday an agreement to acquire Beechcraft for approximately $1.4 billion which it plans to fund using cash and up to $1.1 billion of debt. TXT is not assuming any debt but will assume an estimated $80 million of net pension obligations. The acquisition could close in the first half of 2014, pending regulatory approval.
Fitch estimates new debt associated with the acquisition will increase TXT's pro forma debt/EBITDA at Sept. 30, 2013 to nearly 2.5x compared to 1.8x prior to the acquisition, including estimated EBITDA at Beechcraft. Fitch anticipates TXT will generate sufficient free cash flow (FCF) to reduce debt to around 2.0x within one year based on modest debt reduction, margin improvement at TXT on a standalone basis, and operating improvements at Beechcraft as TXT integrates the business. Margin improvements will be partly offset by restructuring costs in 2014 and inventory purchase price adjustments. Fitch anticipates additional debt reduction in 2015 which could return leverage to the current level or below.
The acquisition of Beechcraft provides TXT with an opportunity to broaden its presence in piston-engine and turboprop aircraft and realize operating efficiencies across the combined business with Beechcraft. Beechcraft also makes light attack military aircraft sold to U.S. and foreign military customers, and it continues to provide service and support to its installed base of Hawker jets, which were discontinued after the company filed bankruptcy in 2012. The transaction increases TXT's exposure to the aerospace and defense business which represents approximately three-fourths of TXT's manufacturing revenue.
Fitch believes much of the value of the acquisition to TXT is concentrated in Beechcraft's customer support business. The business represents nearly one-third of Beechcraft's revenue but generates stronger margins than the general aviation and defense businesses. The favorable margins and recurring nature of the support business mitigate aircraft revenue, which is subject to cyclical demand.
Key Rating Drivers:
The planned acquisition of Beechcraft occurs at a time when TXT's FCF is weak, but Fitch believes this will improve significantly in 2014. Fitch estimates manufacturing FCF for all of 2013 will be near break-even or slightly positive compared to FCF of negative $310 million for the last 12 months ended Sept. 30, 2013 and in excess of a positive $300 million during each of the past several years.
Weak FCF includes the impact of higher inventory at Cessna and Bell due to a ramp-up of production for certain aircraft and lower than expected demand at Cessna. Some of the increase in inventory is expected to reverse due to the timing of deliveries which could increase in the fourth quarter. Also, the conversion to a new enterprise resource planning (ERP) system at Bell created delays in OEM and aftermarket parts shipments which are gradually being caught up.
Fitch estimates FCF will recover in 2014 to approximately $500 million or more as a result of inventory reductions, stronger operating margins, and lower pension contributions. Actual cash flow will be sensitive to demand for business jets and TXT's ability to realize operating improvements at Bell and Textron Systems, and cost synergies at Beechcraft.
TXT's ratings incorporate the well-established market positions of the company's aerospace, defense and industrial businesses; significant progress toward exiting TFC's non-captive portfolio; adequate liquidity; and disciplined cash deployment. Leverage prior to the Beechcraft acquisition is low for the ratings, with manufacturing debt/EBITDA of 1.8x at Sept. 28, 2013. Pro forma leverage (including debt used to fund the acquisition) will be somewhat weak, but should begin to decline during 2014. Other credit measures, including FCF and operating margins, are not as strong, but should begin to improve.
Rating concerns include weak FCF, pressure on the U.S. defense budget that could limit military sales at the Bell and Textron Systems businesses, and potential support required for TFC, although this concern is substantially less than in the past. In addition, TXT's financial performance is constrained by the lack of a meaningful recovery in industry demand for business jets, particularly at the light end of the market where TXT's Cessna business is concentrated. As a result, Cessna currently provides little support to TXT's overall profitability and cash flow. Cessna's unit deliveries and revenue appear likely to decline in 2013, with a return to modestly higher industry demand possible in 2014.
Even if the market starts to recover, Cessna's volumes likely will remain below peak levels for several years, partly reflecting the trend toward larger jets. During 2013, Cessna reduced production to match lower demand but reported a loss through the first three quarters. The fourth quarter could improve, based on normal seasonality and initial deliveries of the new Citation M2 and upgraded Sovereign business jets, which may return Cessna close to break-even profitability for the full year if higher deliveries are realized.
At Sept. 28, 2013, liquidity at the manufacturing business included cash of $444 million and a $1 billion five-year bank facility that expires in 2018 and is available to back commercial paper. The facility includes a maximum debt-to-capitalization covenant of 65% and a requirement that TFC's leverage not exceed 9:1. Fitch calculates these covenants were well within compliance at the end of the third quarter. Liquidity was offset by $104 million of debt due within one year. TXT's long-term debt is well distributed; the earliest maturity is in 2015 and maturities in any single year do not exceed $400 million. Liquidity can be affected by TXT's support for TFC through capital contributions or intercompany loans, but these have been immaterial in 2013. Fitch expects future support for TFC will be minimal.
TXT plans to contribute approximately $200 million to its pension plans for all of 2013, down from $405 million in 2012 and $642 million in 2011. An increase in discount rates during 2013 could potentially reduce the net pension liability as well as future contributions. At the end of 2012, the pension deficit was $1.3 billion (81% funded).
Other uses of cash include capital expenditures which TXT estimates at approximately $500 million in 2013, slightly higher than in 2012. Capex could stabilize and eventually begin to decline as new aircraft enter production. Fitch expects acquisitions to be limited in the near term while TXT integrates Beechcraft.
At the manufacturing business, Bell's revenue and profitability have been temporarily reduced by the implementation of a new ERP system earlier in 2013 and by production delays ahead of a new five-year UAW labor contract that was signed in October 2013. The negative impact of these developments should decline gradually. Stronger demand for commercial helicopters, including new-product introductions, mitigates concerns about military revenue. Deliveries of the H-1 and V-22 military aircraft programs should be generally stable through 2014; a second multi-year contract to deliver 99 V-22 units starting in late 2014 was recently awarded which would mitigate, but not necessarily eliminate, a decline in production after 2014. In addition, Bell has a substantial installed base that could benefit from aftermarket spending and modernization programs.
Textron Systems' revenue has increased modestly, reflecting favorable volumes in programs for unmanned air systems and precision munitions. The business provides a broad mix of products that reduces its exposure to single programs. Revenue at Textron Systems could be flat to slightly higher during the next several years as foreign sales offset reduced defense spending. Margins have been pressured in recent periods by delays in a UAS retrofit development program and by execution problems on a fee-for-service UAS contract which is effectively performing at a break-even level.
Textron Financial Corporation:
The affirmation and equalization of TFC's ratings with those of TXT reflects Fitch's view that TFC is a core subsidiary to its parent, and Fitch's expectation that the acquisition will have a minimal impact on TFC. It is possible that a portion of future Beechcraft aircraft sales may be financed through TFC, although Fitch believes any increase in originations at TFC will be managed in the context of TFC's targeted overall size of approximately $1.5 billion.
The equalization of the TXT and TFC ratings reflects the strong operational and financial linkages between the two companies and the strategic importance of TFC to its parent as illustrated through a support agreement. The agreement requires TXT to maintain full ownership in TFC and ensure TFC has a minimum net worth of $200 million and fixed-charge coverage of 1.25x. Other factors supporting the rating linkage include a shared corporate identity, common management, and the extension of intercompany loans to TFC.
While non-captive receivables remain in the portfolio, TFC is prudently managing the timely liquidation and sale of the golf mortgage and structured assets. The non-captive portfolio totaled $210 million at Sept. 30, 2013, compared to $370 million at Dec. 31, 2012. Fitch views the progress TFC has made in liquidating the non-captive portfolio favorably, and believes its liquidation has significantly reduced credit risk in the portfolio. Asset quality for the first nine months of 2013 improved as non-accrual finance receivables declined 34.3% from Dec. 31, 2012. The structured portfolio, which consists primarily of rail car leases, is the largest portion of the non-captive segment. Fitch believes these leases have lower credit risk given the strong credit quality of the lessee.
Cash collections on liquidated receivables and repayments of receivables have continued to reduce TFC's debt balance. Fitch believes TFC has sufficient liquidity to repay its outstanding debt obligations; however, if cash generated from operations and receivable repayments and liquidations are less than expected, TXT would need to provide further support to TFC. TFC's debt to equity ratio was 1.9x at Sept. 30, 2013, as estimated by Fitch, compared to 2.9x at the end of 2012 and 4.5x at the end of 2011.
The Finance group's captive portfolio totaled $1,379 million, including $825 million at TFC as of Sept. 30, 2013, and consisted primarily of aviation receivables. Non-accrual accounts were 10.7% of TFC's total captive receivables at Sept. 30, 2013, compared to 8.3% at the end of fiscal 2012, due to a decline in the receivables balance. Although the level of non-accrual accounts is relatively high, potential concerns about credit quality in the captive portfolio are mitigated by TFC's experience managing aviation receivables.
At TXT, the ratings are capped in the near term due to higher debt and leverage associated with the Beechcraft acquisition.
Fitch could take a negative rating action if FCF fails to improve to a substantially higher level in 2014, Cessna's business jet market worsens, or margins remain at lower levels due to additional operating challenges or unexpected difficulties integrating Beechcraft. Any future unexpected material support for TFC would be a negative consideration, but this concern is much smaller than in the past due to the significant reduction of TFC's non-captive portfolio in recent years.
At TFC, the Stable Rating Outlook is linked to that of its parent. Positive ratings will be limited by Fitch's view of TXT's credit profile. Fitch cannot envision a scenario where the captive would be rated higher than its parent.
A negative rating action at TFC could be driven by a change in the perceived relationship between the parent and subsidiary, such as if Fitch believed that TFC had become less core to the parent's strategic operations or adequate financial support was not provided in a time of crisis. Additionally, deterioration in asset quality, the generation of consistent operating losses, a material increase in leverage beyond management's target of 7.0x, and/or a reduction in the company's liquidity profile could also yield negative rating actions.
Fitch has affirmed the ratings for TXT and TFC as follows:
--IDR at 'BBB-';
--Senior unsecured bank facilities at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Short-term IDR at 'F3';
--Commercial paper at 'F3'.
Textron Financial Corporation
--IDR at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Junior subordinated notes at 'BB'.
At Sept. 28, 2013, there was approximately $3.3 billion of debt outstanding including $2 billion at the manufacturing business and $1.3 billion in the Finance group of which $856 million was at TFC.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013);
--'Finance and Leasing Companies Criteria' (Dec. 11, 2012);
--'Global Financial Institutions Rating Criteria' (Aug. 15, 2012);
--'Rating FI Subsidiaries and Holding Companies' (Aug. 10, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating FI Subsidiaries and Holding Companies
Global Financial Institutions Rating Criteria -- Effective Aug. 16, 2011 to Aug. 15, 2012
Finance and Leasing Companies Criteria
Parent and Subsidiary Rating Linkage