CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) for Eaton Corporation plc and its indirect subsidiary Eaton Corporation (together 'Eaton') at 'BBB+'. The Rating Outlook is Stable. A detailed list of ratings follows at the end of this release.
KEY RATING DRIVERS
Fitch expects Eaton's credit metrics will improve further to levels that would fully support its 'BBB+' rating as margins and FCF benefit from the largely completed integration of Cooper (acquired in 2012) and additional restructuring actions. The pace of improvement is likely to be slowed by weak demand in certain of Eaton's industrial end markets, which could be a concern through 2016 and into 2017. Eaton recently completed its debt reduction plans related to the acquisition of Cooper and Fitch expects debt will remain stable in a range near $8 billion.
Fitch estimates EBITDA in 2016 will be stable compared to 2015, as higher margins offset lower sales attributable to a small expected organic decline and negative currency movements. As a result, debt/EBITDA of 2.7x at March 31, 2016 may improve only slightly by the end of 2016, to approximately 2.5x as calculated by Fitch. Eaton's credit metrics could improve more quickly than anticipated by Fitch if the company's end markets improve or the company reduces debt further.
Rating concerns include cyclical end markets which are currently pressuring Eaton's results, and future cash deployment for share repurchases and acquisitions that could weaken Eaton's credit metrics if funded by debt, although Fitch does not expect debt to increase materially in the near term. Eaton plans to use a large portion of its FCF to fund a $3 billion share repurchase program through 2018, including approximately $700 million in 2016.
These concerns are mitigated by Eaton's solid FCF, technological capabilities and competitive market positions. Fitch believes the company intends to maintain a strong balance sheet over the long term. Acquisitions were minimal while Eaton integrated Cooper and could eventually increase, particularly in the higher-margin electrical and aerospace businesses. Fitch would expect that in the event of a large acquisition, Eaton could reduce share repurchase to mitigate the negative impact on leverage.
The ratings consider Eaton's diversification which curbs the company's exposure to cyclicality in its industrial end markets. Fitch estimates Eaton's revenue could be down more than 10% over 2015 and 2016, including the negative effect of currency movements, as modest growth in certain markets such as aerospace partly offsets a sharp decline in hydraulics and mixed conditions in Eaton's electrical business. The declines are concentrated in the heavy duty truck, oil and gas and agricultural equipment markets and reflect slow growth in emerging regions and low commodity prices.
In order to support its margins, Eaton implemented a three-year restructuring program in 2015 and is incurring total charges of approximately $400 million over the period, including $140 million planned in 2016 and $130 million in 2017. When completed, the restructuring should reduce the company's annual costs by $400 million. As a result, EBITDA margins could increase by up to 50 bps in 2016 despite lower revenue and could improve further in subsequent years.
Fitch estimates FCF after dividends in 2016 will increase to approximately $1.1 billion compared to $839 million in 2015. The increase in FCF in 2016 reflects integration and restructuring benefits as well as lower pension contributions expected in 2016. Capital expenditures in 2015 were 2.4% of sales in 2015, which Fitch estimates could gradually return to historical levels that have been closer to 3%.
In addition to share repurchases, cash deployment includes pension contributions. Eaton plans to contribute $162 million to global plans in 2016 compared to $330 million in 2015. Eaton contributed $42 million in the first quarter of 2016. As of Dec. 31, 2015, global plans were underfunded by $1.6 billion (73% funded), down from nearly $1.8 billion at the end of 2014. U.S. plans were underfunded by $895 million (77% funded). Eaton closed its U.S. plans to new entrants in 2013. The U.S. plan assumed with the Cooper acquisition was closed and frozen in 2007.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include:
--Sales decline by low- to mid-single digits in 2016 due to weak demand, particularly in the Hydraulics segment, and the negative impact of currency;
--EBITDA margins as calculated by Fitch increase by 50-60 bps in 2016 as Eaton realizes benefits from operating improvements and restructuring, followed by further margin improvement in subsequent periods;
--FCF after dividends increases to approximately $1.1 billion compared to $839 million in 2015;
--No significant long-term debt reduction after 2016;
--Possible increase in acquisition activity;
--Business portfolio continues to be well diversified across end markets and geographies.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
--Sustained increase in EBITDA margins from 15.9% in 2015;
--FFO adjusted leverage declines to 2.5x or below compared to 3.4x in 2015 and 3x in 2016 as projected by Fitch;
--Stronger earnings and disciplined cash deployment support a decline in leverage, including debt/EBITDA consistently below 2x;
--FCF/Total Adjusted Debt increases to a range near the mid-teens or higher compared to 8% in 2015.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Loss of market share due to ineffective product development or higher competition;
--Less diversification that could result in more cyclical results;
--Cash deployment for share repurchases or acquisitions prevents an improvement in credit measures expected by Fitch, including a reduction of debt/EBITDA to well below 2.5x.
LIQUIDITY
Liquidity at March 31, 2016 included approximately $600 million of cash and short-term investments, plus availability under three revolving credit facilities (RCFs) totaling $2 billion. The RCFs have staggered maturities between 2017 and 2019 and are used to back commercial paper. Liquidity was offset by nearly $1.1 billion of debt due within one year, including short-term debt and current maturities of long-term debt.
Debt totaled $8.6 billion at March 31, 2016. The bank credit revolvers and substantially all of Eaton's and Eaton Electric Holdings' long-term debt are guaranteed by Eaton Corporation plc and certain of its U.S. and non-U.S. subsidiaries. Eaton was in compliance with all debt covenants at March 31, 2016.
Eaton Corporation plc's (Eaton plc) borrower group consists primarily of U.S.-based operations of both the original Eaton Corporation (Eaton Corporation U.S.) and Cooper Industries (Eaton Electric Holdings LLC). Eaton's non-guarantor group consists primarily of companies outside the U.S. Concerns about structural subordination are mitigated by minimal debt levels at non-U.S. businesses. Cash flow from U.S. operations is used to service Eaton's debt while dividends are funded primarily from non-U.S. operations. Eaton generally keeps excess cash balances at international companies, and minimizes cash held in the U.S., which maximizes its flexibility to move cash among geographic locations.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Eaton Corporation plc
--Long-Term Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured bank credit facilities at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Eaton Corporation
--Long-Term IDR at 'BBB+';
--Senior unsecured bank credit facilities at 'BBB+';
--Senior unsecured debt at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Eaton Electric Holdings LLC
--Long-Term IDR at 'BBB+';
--Senior unsecured debt at 'BBB+'.
The Rating Outlook is Stable.
Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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