CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) for United Technologies Corporation's (UTC; NYSE: UTX) at 'A'. The Rating Outlook has been revised to Stable from Negative. A detailed rating list follows at the end of this press release.
KEY RATING DRIVERS
The revision of the Rating Outlook to Stable reflects UTC's significant debt reduction in 2013 that totaled $3 billion, combined with the ongoing integrations of Goodrich and IAE that enhance UTC's position on aerospace programs and future aftermarket revenue. Previous concerns about temporarily weak credit metrics have been largely resolved as leverage continues to decline and free cash flow (FCF) remains strong.
UTC plans to reduce debt by another $1 billion in 2014 which would further strengthen its balance sheet. As a result, debt/EBITDA could decline to around 1.75x by the end of 2014 compared to 2.0x at the end of 2013 and a peak level well above 2.5x in late 2012. Debt/EBITDA of 1.75x would still be weak in Fitch's view, but other credit measures are solid including FCF, liquidity and overall financial flexibility. Fitch anticipates credit metrics will continue to improve after 2014 due to ongoing operating improvements and the strong aerospace cycle.
Fitch views UTC's financial flexibility and operating stability as key rating strengths. Cash balances have remained at solid levels even as UTC pays down debt and maintains high spending for R&D and capital expenditures to support its aerospace businesses.
UTC's ratings also incorporate the company's competitive market positions, product and geographic diversification (62% of sales are international including exports), and solid FCF. Significant aftermarket revenue at favorable margins mitigates the impact of cyclicality in UTC's aerospace and building markets. The company has attractive positions on several commercial and military aerospace programs and is well positioned to benefit from rising production of commercial aircraft. UTC's financial results should improve as it completes the integration of Goodrich and IAE into UTC's aerospace business and continues to realign the Building & Industrial Systems group.
The realignment of UTC's business portfolio over the past two to three years, including significant acquisitions and divestitures, has increased the company's already strong presence in commercial and military aerospace markets and focused the commercial businesses on higher-margin revenue. The commercial businesses represented 46% of total revenue in 2013 and nearly 54% of segment profit, partly reflecting a substantial share of services revenue (40%) at the commercial businesses. P&W's large backlog for the geared turbofan engine should help reverse a long-term decline in large commercial engine production. UTC expects to incur restructuring charges of approximately $375 million across all of its businesses in 2014, compared to $481 million in 2013.
Fitch estimates FCF in 2014 will increase to a range of $3.5 billion-$4 billion from $3.3 billion in 2013. The increase reflects operating improvements related to integration and restructuring, and the absence of negative cash flow from discontinued operations in 2013. These items will be partly offset by expected increases in capital expenditures, dividends and working capital requirements.
FCF/total adjusted debt could eventually return to a level approaching 20% or higher as UTC moves past the current investment cycle in aerospace and realizes benefits from restructuring. Historically, UTC maintained the ratio well above 20%, but the ratio is currently in the mid-teens due to peak spending for R&D and capital expenditures on aerospace development programs and to related working capital requirements.
FCF includes the impact of pension contributions which Fitch views as manageable, reflecting an improvement in the funded status over several years. UTC estimated U.S. plans were approximately 95% funded as of March 31, 2014. The company plans to contribute $275 million to global pension plans in 2014 compared to $108 million in 2013. Other cash deployment includes acquisitions and share repurchases which UTC has budgeted at $1 billion each in 2014, subject to acquisition opportunities and other cash uses.
Rating concerns include lower defense spending in the U.S., a slow recovery in global construction markets, and contingent obligations including financing commitments and litigation. Concerns about military spending are mitigated by UTC's position 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. Risks related to financing commitments are centered on commercial aerospace markets where revenue is growing. Commitments extend over several years, however, and concerns about potential funding needs are mitigated by the availability of alternative financing to customers and by minimum requirements for terms of financing.
Another concern includes risks related to developing new aerospace program. Sikorsky's CH-148 helicopter program for the Canadian government has encountered significant delays and cost overruns. Sikorsky is close to resolving final terms of the contract, but profitability over the life of the roughly $4 billion program will be reduced as a result of the additional costs.
At March 31, 2014, UTC's liquidity included $4.5 billion of cash and equivalents, most of which is located outside the U.S., and $4 billion of committed bank facilities that mature in 2016. UTC generally has access to foreign cash, and while much of it would be subject to taxes, Fitch believes UTC has considerable flexibility regarding any repatriation.
Liquidity was offset by $304 million of debt due within one year. UTC's outstanding debt totaled $20 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 integrated into UTC's Aerospace Systems segment. As of March 31, 2014, UTC had repaid approximately $1.9 billion principal amount of $2.9 billion of Goodrich debt assumed with the acquisition, excluding the impact of acquired cash.
A positive rating action is unlikely in the near term while UTC continues to reduce debt and rebuild credit metrics toward stronger levels. However, future developments that may, individually or collectively, lead to a positive rating action include:
--Significant, sustained long term market share gains at Otis, particularly in China which is the most important global market for new elevator equipment and where the share of service revenue is relatively low;
--Materially higher margins resulting from the realignment in the commercial businesses that is expected to produce both revenue and cost synergies;
--Successful long term execution on aerospace development projects such as the CH-53K heavy-lift helicopter and F135 engines on the JSF.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Negative events in UTC's commercial aerospace markets that could reduce airline profitability and limit demand for large commercial aircraft;
--Significant delays or cancellations on military programs at P&W and Sikorsky including the H-60 family of helicopters and the JSF;
--Slower global economic growth that impairs construction activity in UTC's commercial businesses;
--Unexpected challenges in fully realizing anticipated synergies from ongoing integration and restructuring related to Goodrich and the commercial businesses.
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 Stable.
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);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis