Fitch Affirms Raytheon at 'A-'; Outlook Stable

NEW YORK--()--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.

Forcepoint

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.

KEY ASSUMPTIONS

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.

RATING SENSITIVITIES

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.

LIQUIDITY

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.

Applicable Criteria

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

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013385

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013385

Endorsement Policy

https://www.fitchratings.com/regulatory

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Copyright (c) 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.

The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.

Contacts

Fitch Ratings
Primary Analyst
David Petu, CFA
Director
+1-212-908-0280
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Committee Chairperson
Bill Densmore
Senior Director
+1-312-368-3125
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
David Petu, CFA
Director
+1-212-908-0280
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Committee Chairperson
Bill Densmore
Senior Director
+1-312-368-3125
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com