NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Raytheon Company's (RTN) Long-Term Issuer Default Rating (IDR) at 'A-' and Short-Term IDR at 'F2'. The Rating Outlook is Stable. These ratings cover approximately $5.4 billion of debt. See the full list of rating actions at the end of this release.
KEY RATING DRIVERS
RTN's ratings and Outlook are supported by the company's competitive position in the defense industry; good product diversification; large portion of revenues derived from international sales; adequate liquidity; and large backlog. The company's product portfolio is program-agnostic, reducing the risk of large program cuts by the U.S. Department of Defense (DoD). The majority of the company's large programs are well-aligned with DoD priorities.
Fitch views RTN's financial metrics as supportive of the company's ratings, though leverage (debt/EBITDA) is slightly elevated. The company's leverage has deteriorated to approximately 1.5x for the LTM ended July 3, 2016, up from 1.4x at the end of 2014, driven by a slight deterioration in RTN's EBITDA margins. Fitch expects the company's debt level and other credit metrics will be stable over the rating horizon and anticipates RTN's leverage will fluctuate between 1.4x and 1.6x over the next several years.
RTN has good operating discipline and generated solid EBITDA margins in the range of 14.6% to 16.5% over the past four years. The company reported 15.7% EBITDA margins in 2015, down from 16.5% in 2014 primarily due to a change in product mix and lower sales of Patriot programs for international customers. Fitch expects RTN will continue operating with EBITDA margin in the range of 15% to 16% over the rating horizon. In addition, RTN generates strong cash flows. The company's free cash flow (FCF) for the LTM ended July 3, 2016 was approximately $1.7 billion, up from $1.1 billion in 2015, driven largely by lower working capital requirements during the first-half 2016. Fitch estimates RTN will generate more than $1.2 billion FCF (excluding discretionary pension contributions) annually over the rating horizon.
Fitch's rating concerns include RTN's exposure to possible declines in U.S. and international defense spending. The concern is somewhat mitigated by large and increasing international sales and by RTN's demonstrated ability to reduce costs to manage lower revenue expectations. Fitch is also concerned with the impact on cash flows from the pension deficit upon expiration of the Highway and Transportation Funding Act of 2014 (HAFTA) and the completion of FAS/CAS harmonization in 2017. Cash deployment strategies that include increasing dividends and sizable share repurchases are also a concern, as well as the possibility of a sizable acquisition, although Fitch does not expect the company will engage in major acquisition activities in the near future.
RTN spent approximately $940 million on annual net share repurchases and distributed between 85% and 100% of its pre-dividend FCF to shareholders over the past four years. Fitch expects the company will spend approximately $1 billion on share repurchases in 2016. As of July 3, 2016 RTN has repurchased $602 million worth of shares. RTN has increased its dividend payout by an average of 10% annually over the past four years. Fitch expects RTN will maintain its shareholder-friendly cash deployment strategies; however, share repurchases could fluctuate based on available cash after any acquisition activities.
As of Dec. 31, 2015, RTN had a sizable pension deficit of $6.5 billion (74% funded), nearly unchanged from $6.4 billion (76% funded) at the end of 2014. The increase was primarily driven by the decrease in the discount rate and the adoption of updated mortality tables. The domestic pension benefit obligation was $25.4 billion at the end of 2015. Required cash contributions to the company's plans declined significantly in 2015 to $335 million from $650 million in 2014. The decline was primarily driven by HAFTA. RTN expects to make approximately $140 million of required contributions in 2016. Fitch anticipates deterioration in the funded status of the company's pension plans in 2016 due to lower prevailing interest rates and assumes the company will start making up to $500 million of annual discretionary pension contributions beginning 2017.
On May 29, 2015 RTN acquired Websense, Inc. from Vista Equity Partners (Vista) for $1.9 billion in cash and subsequently formed Forcepoint, a cybersecurity joint venture (JV) with Vista. RTN contributed Websense's assets to Forcepoint along with the RTN's existing commercial cyber platform valued at approximately $400 million. Vista invested approximately $343 million for a 19.7% equity stake in the new company. RTN retained cyber products offered to its global defense and intelligence customers.
Fitch views Forcepoint as a credit-neutral, albeit relatively high-risk, venture for the company because of the JV's commercial focus and the potential need for additional acquisitions to build scale to compete with larger enterprise security providers. Most defense contractors have not been successful in diversifying into commercial markets in the past. Additionally, several defense contractors have exited commercial cyberspace market over the past two years.
Vista has the ability to liquidate its ownership in Forcepoint through a put option exercisable at any time two years after May 29, 2015. In the event of a put option exercise, Vista could require RTN to purchase all (but not less than all) of its interest in the JV for cash at a price equal to a fair value of the enterprise as determined under the JV agreement. Additionally, at any time after three years following the closing date, RTN has the option to purchase all (but not less than all) of Vista's interest in Forcepoint at a price equal to a fair value also as determined under the JV agreement.
RTN recognizes Vista's put option as a $343 million redeemable non-controlling interest on its consolidated balance sheet at July 3, 2016. The $343 million was derived from the greater of the estimated redemption value ($343 million) or of the carrying value (estimated at $323 million). Fitch assumes Vista will exercise its put option and it will be in the range of $330 million to $370 million. Fitch recognizes the risk that the cash outlay related to the exercise of the Vista put option may be significantly higher depending on ongoing market valuation of cybersecurity businesses at the time of the put exercise.
U.S. Government Exposure
U.S. government spending trends are key drivers of RTN's financial performance, as the company generated approximately 68% of its 2015 revenues from the U.S. government, mostly from the DoD. As a result, defense spending is a significant driver of RTN's financial performance and credit quality.
Higher U.S. defense spending in fiscal year (FY) 2016 has supported Fitch's credit outlook for the U.S. Aerospace & Defense sector. Investment spending turned upward this year after a three-year trough, and Fitch expects continued solid spending levels in FY2017 and beyond, assuming budget caps are overridden. Although it has not yet been enacted, Fitch views the FY2017 budget request as a good indicator of spending trends. The investment accounts (procurement and R&D) are most relevant to the defense industry, and they have risen solidly from the trough years (FY2013-FY2015). Investment spending in the FY2017 request reaches $184 billion, up from $166 billion in FY2015, although down modestly from FY2016's $188 billion.
Despite higher U.S. defense spending in FY2016 and FY2017, budget caps continue to be a risk. Three agreements between the White House and Congress have provided relief from the Budget Control Act (BCA) of 2011, but projected spending beyond FY2017 is above the budget caps, so caps remain a risk through 2021. Fitch bases its defense ratings on the assumption that the caps will continue to be overridden, but at lower levels than those projected by the government after FY2017
A dramatic and unexpected change in U.S. defense spending policies could negatively impact RTN's credit profile, although Fitch does not see this spending scenario as highly likely. Fitch believes modest declines in defense spending would not necessarily lead to negative rating actions given RTN's current credit metrics, liquidity position and diversified product portfolio. The exposure to the U.S. military spending is also mitigated by the company's international sales at a 32% of total revenues in 2015. Fitch notes, 42% of the RTN's backlog at July 3, 2016 consisted of international programs.
Fitch's key assumptions within the rating case for RTN include:
--Low-single-digit revenue annual growth driven by higher international sales and improving U.S. military spending;
--Steady EBITDA margins in the range of 15% to 16%;
--Combined net share repurchases and dividend payments will be in the range of 70% to 95% of pre-dividend FCF, depending on acquisitions and discretionary pension contributions;
--Post-dividend FCF margin will decline and remain at approximately 3%, down from a historical range of 4% to 5%. Fitch expects FCF margin will decrease due to discretionary pension contributions;
--Capital expenditures will remain steady at 2% of revenues, annually;
--Debt level will remain steady and the company will refinance its maturities;
--The company will reduce share repurchases if it makes material acquisitions;
--Vista will exercise its put option in 2017 and it will be in the range of $330 million to $370 million;
--The company will make bolt-on small- to medium-sized acquisitions up to $500 million annually (Vista put option is included in the $500 million acquisition assumption in 2017);
--The funded status of pension plans will deteriorate in 2016 and the company will start making up to $500 million of annual discretionary pension contributions.
Fitch would consider a negative rating action if the company's leverage (debt to EBITDA) or FFO adjusted leverage deteriorate and remain within the ranges of 1.5x-1.7x and 2.7x-2.9x, respectively, driven by aggressive debt-funded acquisitions, share repurchases, or unsuccessful attempts to reduce costs in line with potential revenue reductions.
A positive rating action is unlikely unless the company modifies its cash deployment strategy which currently returns 85% to 90% of pre-dividend FCF to shareholders in the form of share repurchases and dividends.
At July 3, 2016, RTN had a liquidity position of $4 billion, consisting of $2.7 billion of cash and investments as well as $1.3 billion of credit facility availability. In November 2015 RTN replaced its $1.4 billion revolving credit facilities with a $1. 3 billion RCF that will mature in November 2020. RTN's liquidity declined significantly in 2015 due to cash outlays related to the Websense acquisition. The company maintained approximately $6 billion in liquidity prior to the acquisition, but Fitch expects liquidity will remain at or slightly above $4 billion over the rating horizon.
RTN's capital structure consists of senior unsecured credit facilities and senior unsecured notes. In addition, the company can issue up to $1.3 billion in commercial paper which would be backstopped by the RCF. The next large maturities are in March and December of 2018 when a total of $591 million of senior unsecured notes are due. Fitch believes the company will be able to repay these notes with cash on hand, but refinancing is more likely, as we expect the company will maintain its current leverage.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--IDR at 'A-';
--Senior unsecured debt at 'A-';
--Credit facilities at 'A-';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
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.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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