CHICAGO--(BUSINESS WIRE)--Fitch Ratings expects to assign a rating of 'BBB-' to Textron Inc.'s (TXT) planned $600 million of fixed-rate senior unsecured notes. The notes will include a mix of seven- and 10-year maturities. Fitch also expects to rate TXT's planned $500 million bank term credit facility at 'BBB-'. The Rating Outlook is Stable. A full rating list follows at the end of this release.
Proceeds will be used to help fund the $1.4 billion acquisition of Beechcraft which is expected to close in the first half of 2014 pending regulatory approval. TXT will assume an estimated $80 million of net after-tax pension obligations.
KEY RATING DRIVERS
Fitch estimates the new debt will increase TXT's pro forma debt/EBITDA at Dec. 28, 2013 to approximately 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 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. Beechcraft also makes light attack military aircraft sold to U.S. and foreign military customers, and continues to provide service and support to its installed base of Hawker jets, which were discontinued after the company filed for 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.
The planned acquisition of Beechcraft occurs at a time when TXT's FCF is weak, but Fitch believes this will improve significantly in 2014. Manufacturing FCF in 2013 was just above break-even compared to levels above $300 million in previous years. Weak FCF in 2013 included the impact of higher inventory at Cessna and Bell Helicopter (Bell) due to a ramp-up of production for certain aircraft and lower than expected demand at Cessna. 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, TXT's ability to realize operating improvements at Bell and Textron Systems, and cost synergies at Beechcraft.
TXT's ratings incorporate well-established market positions in the company's aerospace, defense and industrial businesses; significant progress toward exiting Textron Financial Corporation's (TFC) 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 just over 1.8x at Dec. 28, 2013 on a preliminary basis. 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 Bell and Textron Systems, and potential support required for TFC, although this concern has substantially lessened. 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 declined in 2013, and any recovery in industry demand in 2014 could be modest.
Even if the market starts to recover, Cessna's volumes could 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 for the year. The fourth quarter showed some improvement due to normal seasonality and initial deliveries of the new Citation M2 and upgraded Sovereign business jets.
At Dec. 28, 2013, liquidity at the manufacturing business included cash of nearly $1.2 billion 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. Liquidity was offset by $8 million of long-term debt maturities 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, before considering planned debt issuance. Liquidity can be affected by TXT's support for TFC through capital contributions or intercompany loans; however, these were immaterial in 2013, and TXT received dividends from TFC in each of the past two years. Fitch expects future support for TFC will be minimal.
TXT contributed $194 million to its pension plans in 2013 and expects to contribute $80 million in 2014. An increase in discount rates and favorable asset returns contributed to a reduction in the net pension liability to approximately $200 million at the end of 2013 from $1.3 billion one year earlier. Other uses of cash include acquisitions, which Fitch expects will be limited in the near term while TXT integrates Beechcraft.
At TXT's manufacturing businesses, Bell's revenue and profitability have been 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, and stronger demand for commercial helicopters mitigates concerns about military revenue.
Textron Systems provides a broad mix of products that reduces its exposure to single programs. After declining in 2013, revenue at Textron Systems could increase in 2014 as higher unmanned air systems revenue and foreign military sales offset pressure on defense spending. Margins remain below historical levels but recovered modestly in 2013 and could improve again in 2014, reflecting the impact of higher revenue and ongoing efforts to address previous execution challenges.
TEXTRON FINANCIAL CORPORATION
TFC's ratings are equalized with those of TXT, reflecting Fitch's view that TFC is a core subsidiary to its parent. Fitch expects the Beechcraft acquisition will have a minimal impact on TFC. It is possible that a portion of future Beechcraft aircraft sales may be financed through TFC, though 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. Also supporting the rating linkage are a shared corporate identity, common management, and the extension of intercompany loans to TFC.
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 substantially in 2014, Cessna's business jet market worsens, or TXT's overall margins are negatively affected by 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 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 if 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 expects to rate TXT's planned debt as follows:
--Senior unsecured notes 'BBB-';
--Senior unsecured bank term credit facility 'BBB-';
Fitch's existing ratings for TXT and TFC are as follows:
--Senior unsecured bank facilities 'BBB-';
--Senior unsecured debt 'BBB-';
--Short-term IDR 'F3';
--Commercial paper 'F3'.
Textron Financial Corporation
--Senior unsecured debt 'BBB-';
--Junior subordinated notes 'BB'.
The Rating Outlook is Stable.
At Sept. 28, 2013, there was approximately $3.3 billion of debt outstanding including $2 billion at the manufacturing business ($1.9 billion as of Dec. 28, 2013) 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:
Global Financial Institutions Rating Criteria
Finance and Leasing Companies Criteria
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage