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Fitch Affirms Flextronics' Ratings at 'BBB-'; Outlook Stable

CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Flextronics International Ltd.'s (Flextronics) Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook is Stable.

The ratings and Outlook reflect Fitch's expectations for stable operating profit margins and solid annual free cash flow (FCF) over the intermediate term, despite the potential for continued top line volatility.

For fiscal 2015, Fitch anticipates flat to slightly negative revenue growth, driven by the delay of new programs ramps until the second half of the year. Fitch believes Lenovo Group Ltd.'s (Lenovo) acquisition of Motorola Mobility (Motorola Mobility), Flextronics' largest customer, will weigh on Flextronics' top line beginning in fiscal 2016, given Lenovo's internalized manufacturing model.

Over the longer term, Fitch expects low-single-digit revenue growth through the cycle, driven by strong customer relationships and share in mature traditional end markets. Fitch believes faster growing end markets, including medical, automotive, industrial automation, could accelerate growth to mid-single digits through the cycle.

Fitch expects operating profit margin will remain in the low single digits but strengthen gradually from an increasing mix of sales in non-traditional end markets and lower exposure to high-velocity markets, mainly handsets. As a result, Fitch anticipates operating EBITDA to bottom in fiscal 2016 at just over $1 billion and resume growth in fiscal 2017.

Fitch anticipates annual FCF will exceed $500 million through the cycle, driven by consistent profitability and solid working capital efficiency. Fitch believes advance payments received from customers in fiscal 2014 to offset inventory investments associated with underperforming programs support the industry's maturity and strengthened FCF profile.

Fitch anticipates Flextronics will use annual FCF for a combination of acquisitions and share repurchases. Fitch expects acquisitions will be smaller and focused on access to technologies and customers in faster growing markets. At the same time, Flextronics is targeting 50% of FCF to be distributed to shareholders through stock buybacks.

Credit protection measure should remain in-line with the rating. Fitch expects total leverage (total debt to operating EBITDA) below 2.5x and debt adjusted for off-balance sheet accounts receivable securitization and operating leases below 3.5x. Fitch estimates total leverage was 1.9x and operating EBITDA to gross interest expense was more than 17.8x for fiscal 2014.

KEY RATING DRIVERS:

Rating strengths include the following:

--Significant advantage in scale and scope of operations as the second largest provider of electronics manufacturing services (EMS) in the world;

--Favorable industry trends toward increased outsourcing of manufacturing, particularly in non-traditional end-markets such as industrial and medical, where Flextronics shares a leading position;

--Strategic positioning in increasingly complex EMS product offerings including product design, engineering, and product lifecycle management which enhance the value of EMS partnerships for customers;

--Positive annual FCF through the cycle, driven by higher profitability in expansionary periods and cash from the lower working capital requirements during a downturn.

Ratings concerns include the following:

--Vulnerability to execution missteps, inherent to the EMS industry's low profit margin business profile;

--A highly competitive environment which pressures profitability across the industry;

--Customer concentration risk, with its top 10 customers accounting for roughly half of revenue in fiscal 2014;

--Exposure to the cyclicality of the IT industry and the broader macro economy through a high proportion of consumer and networking infrastructure business.

Liquidity as of March 31, 2014 was solid and consisted of:

--$1.6 billion in cash;

--An undrawn $1.5 billion senior unsecured revolving credit facility expiring March 2019.

More than $500 million of annual FCF also supports liquidity.

Flextronics also utilizes asset-backed securitization programs and an accounts receivable factoring program for additional liquidity purposes. These programs are located off balance sheet:

--$500 million Global ABS program (of which $400 million is committed);

--$300 million committed North American ABS program.

Total securitization funding at March 31, 2014 was $730 million, and receivables not yet collected under the accounts receivable sale program were $341.8 million. These amounts are included in Fitch's adjusted debt calculation.

Total debt as of March 31, 2014 was $2.1 billion and consisted of:

--$600 million in senior unsecured term loan debt due August 2018;

--$500 million in senior unsecured term loan debt due March 2019;

--$500 million in 4.625% senior unsecured notes due February 2020; and

--$500 million in 5.0% senior unsecured notes due February. 2023.

RATING SENSITIVITIES:

Negative:

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

--Secular shifts or a large customer loss resulting in margin compression with limited visibility on the potential to return profit margins to historical levels.

--Long term, sustained leverage above 2.5x (or 3.5x on an adjusted debt basis) as a result of debt-financed acquisition(s) or shareholder friendly activities, or structurally lower EBITDA.

Positive:

--Upside movement in the ratings is limited given Flextronics' thin operating margin profile and capital intensive business model. This is exacerbated by significant volatility driven by product concentration, product iteration cycles, and potential volatility in the demand for consumer electronics. Fitch views these factors as a limit on the company's ability to achieve higher ratings in the near term.

--Greater diversification into markets with significantly lower cyclicality would strengthen the credit profile; however, this may not result in a positive rating action by itself. Fitch believes a positive rating action would also require sustainably and structurally lower leverage through the cycle (below 1.5x debt to EBITDA, or below 2.5x on an adjusted debt basis).

Fitch has affirmed Flextronics's ratings as follows:

--Long-term IDR at 'BBB-';

--Senior unsecured debt at 'BBB-'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology', dated May 28, 2014;

--'Evaluating Corporate Governance', dated Dec. 12, 2012;

--'Rating Technology Companies', dated Aug. 9, 2012.

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Evaluating Corporate Governance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=694649

Rating Technology Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=682324

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=836335

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Contacts

Fitch Ratings
Primary Analyst
Jason Pompeii
Senior Director
+1 312-368-3210
Fitch Ratings, Inc.
70 W Madison St.
Chicago, IL 60602
or
Secondary Analyst
John Witt, CFA
Senior Director
+1 212-908-0673
or
Committee Chairperson
Sean Sexton
Managing Director
+1 312-368-3130
or
Media Relations, New York
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com