CHICAGO--(BUSINESS WIRE)--Fitch Ratings has placed the long- and short-term ratings for Parker-Hannifin Corporation (PH) on Rating Watch Negative following the company's announcement that it has agreed to acquire CLARCOR Inc. for $4.3 billion in cash including the assumption of net debt.
Fitch currently rates PH's long-term Issuer Default Rating (IDR) 'A' and short-term IDR 'F1'. The transaction is subject to shareholder and regulatory approvals, and Fitch expects to downgrade PH's long-term and short-term ratings by one notch when these approvals have been received. The rating action affects approximately $3.2 billion of debt outstanding as of Sept. 30, 2016.
KEY RATING DRIVERS
The Rating Watch Negative reflects the expected increase in PH's financial leverage, which Fitch believes will remain above historical levels although some reduction in debt and leverage is likely following completion of the acquisition. PH plans to finance the transaction, which will total around $4.5 billion including transaction costs and fees, with approximately $3 billion of debt and $1.5 billion of cash. Fitch expects this incremental debt would drive debt/EBITDA to above 3x from 2.1x at Sept. 30, 2016. Subsequent to the acquisition, PH plans focus its free cash flow on debt reduction while moderating its share repurchases, enabling leverage to improve to around 2x in three years. Prior to the recent downturn, PH's leverage had ranged from 1x to 1.5x.
CLARCOR is a market leader in global industrial filtration with a business mix that is complementary to PH's filtration business. This enables cost synergy opportunities totalling $140 million three years after closing at a one-time cost of $90 million. More than 80% of its revenues are aftermarket, lowering the risk profile of the combined business.
CLARCOR generated revenues of $1.4 billion and EBITDA of around $250 million in 12 months ended Aug. 27, 2016. The company has had weak organic growth and some margin contraction over the past three years. The acquisition will nonetheless be beneficial to PH's margins as CLARCOR is a higher margin business, with an EBITDA margin of around 18% vs. 14% for PH for the LTM period.
The ratings and Outlook take into account PH's strong market positions in diversified end markets and solid operating performance over time. The ratings also consider the current weakness in PH's results due to macroeconomic headwinds, particularly in natural resource markets. Sales were off 10.6% in fiscal 2016 on top of a 3.8% decline in fiscal 2015, and are expected to be flat in fiscal 2017.
PH's operating margin narrowed by 160bps in fiscal 2016 to 11% as the effect of lower volumes was offset in part by restructuring and business realignments made in recent years. Fitch expects EBIT margins will stabilize and begin to recover in fiscal 2017 and that ongoing restructuring and organizational simplification should yield some upward movement in margins in successive cycles. The acquisition of the higher-margin CLARCOR business and the expected synergies will provide additional margin upside over the next three years.
Free cash flow (FCF) after dividends of around $700 million annually should improve following the integration of CLARCOR. Fitch expects PH will moderate its share repurchases over the next few years as it focuses on repaying acquisition debt.
The ratings are supported by:
--Leading manufacturer of motion and control technology resulting in significant customer, product and end market diversification, reducing operating volatility through the cycle;
--Acquisition of CLARCOR strengthens the company's filtration business, adding a higher-margin business with an after-market focus and more stability through cycles;
--Solid annual free cash flow (FCF) after dividends of around $700 million annually, with some upside following the integration of CLARCOR.
Credit concerns include:
--Higher financial leverage following acquisition of CLARCOR; Ongoing share repurchases and the potential for additional bolt-on acquisitions could slow the pace of deleveraging;
--Subdued organic revenue growth rates for the majority of revenues in North America and Europe with less exposure to faster growing developing economies;
--Need for steady stream of new product introductions to offset profit erosion for seasoned products.
Fitch's key assumptions within the rating case for PH include the following:
--PH closes on the acquisition of CLARCOR on or before Sept. 2017.
--Improvement in EBITDA margins driven by the CLARCOR acquisition and related synergies and PH's ongoing restructuring efforts.
--The majority of FCR is directed to debt reduction for the first three years following the acquisition.
--Debt/EBITDA moves above 3x initially and recovers to around 2x in three years.
Fitch expects to downgrade PH's long- and short-term ratings by one notch when shareholder and regulatory approvals for the CLARCOR acquisition have been received, reflecting higher financial leverage, including an expected increase in debt/EBITDA to above 1.75x and FFO-adjusted leverage above 3.0x for a sustained period.
In the event the CLARCOR acquisition is not consummated, Fitch would anticipate removing the Rating Watch Negative and affirming PH's ratings, with the expectation that PH's credit profile would improve due to a gradual recovery in revenues and margins together with steady debt levels.
Fitch believes PH's liquidity is solid. As of Sept. 30, 2016 liquidity consisted of:
--$2.14 billion of cash and marketable securities, of which $2.10 billion was located overseas and $39 million in the U.S.
--$1.5 billion of availability under the company's $2 billion RCF, net of $537 million of CP outstanding as of Sept. 30, 2016. The revolver more than fully backs PH's $1.85 billion CP program.
--Free cash flow (FCF) after dividends of around $700 million annually, with some upside following the integration of CLARCOR.
FULL LIST OF RATING ACTIONS
Fitch has placed the following on Rating Watch Negative:
--Long-term IDR 'A';
--Senior unsecured credit facilities 'A';
--Senior unsecured notes 'A';
--Short-term IDR 'F1';
--Commercial paper 'F1'.
Date of Relevant Rating Committee: Dec. 1, 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.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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