Fitch Affirms Eaton at 'BBB+'; Rates Eaton Capital's Planned Sr Unsec Notes 'BBB+'; Outlook Stable

CHICAGO--()--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+'. Fitch has also assigned a rating of 'BBB+' to Eaton Capital Unlimited Company's planned benchmark issuance of fixed-rate euro-denominated senior unsecured notes.

Proceeds will be available for general corporate purposes, most of which Fitch anticipates will be directed to repayment of debt schedule to mature in 2017. The new notes will have a similar guarantee structure to existing debt at other Eaton entities, including guarantees by Eaton Corporation plc, Cooper Industries, Turlock B.V., and certain other subsidiaries of Eaton Corporation plc.

The Rating Outlook is Stable. A detailed list of ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings for Eaton consider the company's product and geographic diversification which mitigates cyclicality in its industrial end markets. Fitch estimates Eaton's revenue could be down by more than 10% over the two-year period between 2015 and 2016, including the negative effect of currency movements, as growth in certain markets such as commercial aerospace partly offsets an extended decline in hydraulics and mixed conditions in Eaton's electrical business. Sales declines are concentrated in the heavy duty truck, oil and gas, and agricultural equipment markets and reflect the impact of slower growth in emerging regions and low commodity prices.

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 2.6x at June 30, 2016 may be nearly unchanged at the end of 2016. Beyond 2016, Fitch expects Eaton's credit metrics will improve to levels that would fully support its 'BBB+' rating as margins and free cash flow (FCF) benefit from the previous integration of Cooper and additional restructuring actions. The pace of improvement in margins is likely to be slowed by weak demand in certain of Eaton's industrial end markets which could be a concern into 2017. Fitch expects debt will remain stable in a range near $8 billion.

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. However, Fitch expects debt will be stable in the near term and that Eaton will use a large portion of its FCF to fund a $3 billion share repurchase program through 2018, including approximately $700 million in 2016. Share repurchases amounted to $295 million in the first half.

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 repurchases to mitigate the negative impact on leverage.

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 $145 million planned in 2016 and $130 million in 2017. When completed, the restructuring should reduce the company's annual costs by $400 million, including incremental benefits of $190 million in 2016 on an annualized basis. As a result, EBITDA margins could increase slightly in 2016 although it could be challenging to achieve Fitch's original estimate of an increase of up to 50 basis points (bps) for the full year given the relatively steady margin in the first half. An increase in margins will depend on the effectiveness of Eaton's restructuring program and stabilization in revenue which fell 6.6% in the first six months.

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 2.5% of sales in the first half of 2016, 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 $74 million in the first half of 2016. As of Dec. 31, 2015, global plans were underfunded by $1.6 billion (73% 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 June 30, 2016 included $469 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 $8.4 billion at June 30, 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 June 30, 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+'.

Fitch has assigned the following ratings:

Eaton Capital Unlimited Company

--Long-Term IDR '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/site/re/869362

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Contacts

Fitch Ratings
Primary Analyst
Eric Ause, +1-312-606-2302
Senior Director
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip Zahn, +1-312-606-2336
Senior Director
or
Committee Chairperson
Stephen Brown, +1-312-368-3139
Senior Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eric Ause, +1-312-606-2302
Senior Director
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip Zahn, +1-312-606-2336
Senior Director
or
Committee Chairperson
Stephen Brown, +1-312-368-3139
Senior Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com