Fitch Affirms HON at 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed Honeywell International Inc.'s (HON) Long- and Short-term Issuer Default Ratings (IDR) at 'A'/'F1'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

On Oct. 6, 2016, HON reduced its sales and margin guidance for 2016, including a 1%-2% decline in organic sales for the year compared to a 1% increase originally anticipated. HON also announced a new restructuring program, the adoption of an accounting change related to stock compensation, and a possible debt refinancing in the fourth quarter of 2016 (4Q16). These developments, combined with numerous operating changes related to acquisitions, divestitures and the recent realignment of the Automation and Control Services segment, create some challenges in assessing trends in HON's financial performance.

Fitch recognizes the risks related to weak conditions in certain of HON's end markets and the negative impact on profitability. However, the affirmation of HON's ratings incorporates Fitch's view that the company's strong credit fundamentals remain intact and that the company will be able to effectively adjust to the near-term headwinds.

Despite the reduced outlook for 2016, Fitch believes HON's long-term financial performance should benefit from a stronger business mix related to recent acquisitions and divestitures, cost reductions from restructuring, ongoing operating improvements and segment realignments. The company is currently in the midst of several material changes to its operating profile including the $1.5 billion acquisition in August 2016 of Intelligrated that will become part of the Safety and Productivity Solutions segment.

Other changes include the spin-off of the $1.3 billion-sales Resins and Chemicals business (AdvanSix) effective Oct. 1, 2016, the reorganization of HON's Automation and Controls Solutions business into two segments in 3Q16, and the divestiture of Honeywell Technology Solutions for $300 million in September. These transactions reflect HON's ongoing actions to stay focused on higher-growth, high-margin business where it can leverage its technological capabilities.

Partly related to these transactions, HON is implementing $250 million of additional restructuring which would bring total restructuring actions in 2016 to more than $300 million. The incremental restructuring is intended to generate at least $200 million of annual cost savings when completed, much of which will occur in 2017.

Rating concerns include significant cash deployment for acquisitions and share repurchases which are contributing to an increase in debt and leverage. Funds from operations (FFO) adjusted leverage was 2.7x at June 30, 2016 compared to 2.2x as recently as the end of 2014, and debt-to-EBITDA increased to 1.7x at June 30, 2016 from 1.2x at Dec. 31, 2014. When including the impact of ongoing acquisitions, divestitures and debt issuance, Fitch estimates FFO adjusted leverage could increase to nearly 3x at the end of 2016 and debt/EBITDA could be near 2x.

Fitch views these levels as weak for the ratings but the trend is not unexpected given HON's high cash deployment, including acquisitions, which can be lumpy. Recent acquisitions have been for businesses that are central to HON's operating strategy and already generate good margins, so in our view integration risk is not a significant concern. Other considerations that offset HON's higher leverage include considerable financial flexibility due to the company's high liquidity, solid free cash flow (FCF) that provides flexibility to fund discretionary spending or reduce debt, well-distributed debt maturities, and well-funded pension plans.

Segment margins have declined in 2016, although they remain at solid levels following an aggregate improvement of more than 500 bps between 2012 and 2015 as a result of better product mix and operating improvements. The recent decline in margins reflects slow economic growth, weakness in business jets and commercial helicopters, high inventories in the distribution channel in the Productivity Solutions business, and cyclical trends in the aerospace business and at UOP.

HON's aerospace segment continues to incur costs for OEM incentives related to content on new programs including the Boeing 737MAX and Airbus A350 among others. Incentives are expected to peak in 2016 at approximately $250 million before beginning to moderate in 2017. The incentives reduce HON's near-term profitability but should support financial results over the long lifecycles of the programs. At UOP, the negative impact of lower equipment orders related to oil and gas could stabilize by the end of 2016, with improved results possible next year.

Fitch estimates operating cash flow in 2016 will be steady but recurring increases in dividends could reduce FCF. Capital expenditures remain elevated in 2016 as HON invests in product development and production capacity across its businesses. Expenditures could begin to decline sometime in 2017 as these projects are completed.

Asbestos and environmental payments continue to be a recurring use of cash and likely will continue for an extended period due to the nature of the liabilities. Asbestos payments totaled $209 million in 2015 and $99 million in 1H16, partly offset by $72 million of asbestos insurance receipts. Environmental payments were $273 million in 2015 and $77 million in 6M16. The timing of payments can vary and Fitch expects cash outlays for these liabilities will be generally steady.

HON's pension plans were 95% funded at the end of 2015 and the company has not been required to make contributions to its U.S. plans for several years. It makes modest contributions to foreign plans, including $160 million planned in 2016.

Rating strengths include HON's strong operating profile that includes product and geographic diversification, competitive positions in its aerospace and industrial businesses, consistently positive FCF, and ability to generate relatively stable financial results through economic cycles compared to its industrial peers. High technology content across the company's businesses positions it to address the risk of disruption from rapid changes in HON's end markets.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

--Spending for acquisitions and share repurchases in 2016 continue to be substantial but at lower levels compared with $7 billion of spending in 2015;

--Debt increases to approximately $15 billion at the end of 2016 from $12 billion in 2015;

--Sales grow by low single digits in 2016 as acquisitions offset divestitures, along with a slight decline in organic growth, and negative foreign currency movements;

--EBITDA margins are slightly lower in 2016;

--FCF in 2016 lower at approximately $2.5 billion compared with $2.7 billion in 2015 as steady operating cash flow is more than offset by higher dividends;

--Cash payments for asbestos and environmental liabilities continue to be material but manageable.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--EBITDA margins decline consistently below a level in the mid-teens compared to the high teens currently;

--FCF-to-total adjusted debt falls below 10%;

--Funds from operations (FFO) adjusted leverage is consistently above 3.0x;

--Debt/EBITDA increases above 2x. Fitch expects leverage could reach this level or even slightly higher on a temporary basis during periods of high investment, but would be lower than 2x during strong parts of HON's business cycle. This level was updated from 1.5x previously to incorporate HON's strong financial capacity to reduce leverage quickly from FCF and, in certain circumstances, high cash balances outside the U.S. although the cash is subject to taxes;

--An increase in contingent asbestos or environmental liabilities leading to significantly higher annual cash payments.

Fitch expects HON's active cash deployment for acquisitions and share repurchases makes a positive rating action unlikely in the near term. However, future developments that may, individually or collectively, lead to a positive rating action include:

--Consistently strong FCF, defined as FCF-to-total adjusted debt, near 25% or higher;

--A material reduction in leverage, including debt/EBITDA near 1.0x or below;

--A long-term reduction in asbestos and environmental liabilities;

--Further margin expansion.

LIQUIDITY AND DEBT STRUCTURE

Liquidity at June 30, 2016 included $5 billion of cash, not including short-term investments. Much of HON's cash is located outside the U.S. and is subject to taxes on repatriated earnings although it is available to fund overseas acquisitions. Liquidity also includes a $4 billion credit facility that matures in 2021 and two $1.5 billion 364-day credit agreements that expire in April 2017 and August 2017. The 364-day facility scheduled to expire in August was put in place prior to the Intelligrated acquisition and is subject to mandatory reductions following HON's completion of financing used to repay commercial paper (CP) issued to fund the acquisition.

Liquidity at June 30, 2016 was offset by $3.8 billion of CP and short-term borrowings and $618 million of long-term debt maturities. Long-term debt maturities after 2016 are well distributed with maturities through 2041. HON plans to refinance at least a portion of approximately $2.2 billion of debt maturities scheduled through 2019.

FULL LIST OF RATINGS

Fitch has affirmed the following ratings with a Stable Outlook.:

--Long-Term IDR at 'A';

--Senior unsecured bank credit facilities at 'A';

--Senior unsecured debt at 'A';

--Short-Term IDR at 'F1';

--Commercial paper at 'F1'.

The Rating Outlook is Stable.

HON's outstanding debt totaled $14 billion at June 30, 2016.

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

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

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Contacts

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+1-312-606-2302
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or
Secondary Analyst
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Senior Director
+1-312-606-2336
or
Committee Chairperson
Craig Fraser
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or
Media Relations:
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Email: alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eric Ause
Senior Director
+1-312-606-2302
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip Zahn
Senior Director
+1-312-606-2336
or
Committee Chairperson
Craig Fraser
Managing Director
+1-212-908-0310
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com