NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded ITT Corporation's (ITT) long-term Issuer Default Rating (IDR) to 'BBB+' from 'A-' and affirmed its short-term IDR at 'F2'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. The ratings apply to approximately $11 million of short term debt as of Sept. 30, 2015.
KEY RATING DRIVERS
The downgrade of ITT's ratings reflects Fitch's expectation that the company has added a meaningful amount of debt to fund the recent acquisition of Wolverine Automotive Holdings Inc. (WAH) for $300 million. The expectation of increased leverage reflects ITT's low cash balance in the U.S., which should have made it necessary for the company to access the commercial paper (CP) market to fund a large portion of WAH's acquisition.
Since the spinoff of its defense and water businesses into standalone companies (Exelis Inc. and Xylem Inc., respectively) in 2011, ITT has maintained minimal debt, which Fitch viewed as an important mitigating factor to material net asbestos liabilities retained as part of the separation. Fitch expects ITT's debt levels will be higher going forward. Even though ITT's on-balance-sheet leverage and other credit metrics are strong when excluding its asbestos exposure, the company's financial flexibility to meet an unexpected rise in asbestos payments or other negative asbestos-related developments will be slightly reduced.
The ratings incorporate ITT's well-established market positions, cyclical end-markets, competitive operating environment, solid liquidity and organic growth in key end-markets. The company has achieved sizable market share gains with the Motions Technologies reporting segment by increasing sales to original equipment manufacturers (OEMs) and expanding its aftermarket presence. The company's large installed base allows it to derive approximately 30% of revenue and a large percentage of operating income from aftermarket sales, affording the company relative revenue and margin stability during economic downturns. ITT benefits from a balance across business cycles and from conservative financial policies that include its commitment to maintaining investment-grade ratings.
On Oct. 5, 2015, ITT completed its acquisition of WAH, the Michigan-based manufacturer of technologies for automotive braking systems and specialized sealing solutions, for $300 million in cash consideration or 7.9x LTM EBITDA. WAH was a supplier to ITT's Motion Technologies segment and is expected to generate $180 million of revenue in 2015 (including sales to ITT) with roughly 40% of that revenue stemming from aftermarket sales.
Fitch expects ITT will have moderate debt and low leverage metrics including debt/EBITDA below 1.0x even after recent acquisitions. Fitch expects total debt at the end of 2015 will be in the $300 million range. Low leverage mitigates the company's sizable asbestos liabilities retained subsequent to ITT's separation from Xylem Inc. and Exelis Inc. in 2011. ITT has also improved operating margins materially in recent years, further contributing to its improved cash flow generation.
Fitch expects the company's post-dividend free cash flow (FCF) will increase to at least $125 million in 2015 and more than $150 million in 2016 compared to $80 million in 2014. FCF margin is expected to be north of 5% for full-year 2015, up from 3% in 2014. FCF was pressured in 2013 and 2014 due to margin contraction, sizable restructuring costs and elevated capital expenditures to add production for new business wins in the Motion Technologies segment. FCF should be enhanced in the next several years by lower restructuring costs, anticipated margin improvements in the Interconnect Solutions segment in early 2016, margin expansion from accretive acquisitions completed in 2015 and the greater contribution of the higher-margin Motion Technologies segment.
The size of the asbestos liability remains the primary concern although Fitch notes the company has recently reduced the expected future liability by more than $100 million by consolidating its legal representation and entering into a fixed-fee arrangement in respect to the legal expenses over the next 10 years. The company's estimated 10-year pre-tax liability net of expected recoveries from insurers and other responsible parties totalled approximately $632 million as of Sept. 30, 2015, down from $747 million at Dec. 31, 2014. The large asbestos liability is mitigated by moderate projected annual cash funding requirements ranging from $15 million to $25 million over the next five years and expected to increase to approximately $35 million to $45 million thereafter.
Other ratings concerns include the cyclical nature of the ITT's end-markets which is somewhat offset by large aftermarket content and solid product and geographic diversification. Additionally, Fitch notes a highly competitive environment, and the firm's small size relative to some large competitors. The company derived 40% of its revenue from North America, 31% from Europe and 14% from Asia in 2014. Fitch notes the company's high capital intensity with capex as a proportion of revenue historically falling in the 4% to 5% range.
Fitch expects revenue to be down roughly 10% in 2015 mostly driven by unfavorable currency translation ($155 million through September 2015) and weak organic revenue stemming from challenging conditions in the industrial, oil and gas markets. Most of the organic weakness has thus far been concentrated in the Interconnect Solutions and Control Technologies segments. In the Interconnect Solutions segment, weakness in the energy sector, declining revenue from end-of-life non-strategic connector platforms, and operational disruptions from the relocation of certain North American operations have contributed to the decline in sales. Within the Control Technologies segment, shifts in order patterns at CT Aerospace and within the commercial OEM business as well as softness in both the aerospace aftermarket and energy absorption projects in the U.S. and China have been factors. Fitch notes that the ongoing operational improvements and 80 basis points (bps) of consolidated gross margin expansion through the first nine months of 2015 have mitigated the effects of the sales decline.
ITT's global pension obligations totalled approximately $412 million (including the U.S.) as of December 2014. The U.S. and international plans are currently underfunded by $51.2 and $86.5 million, respectively, corresponding to an 84% funded status for the U.S. plan as of December 2014. ITT is not required to fund the majority of its international pension plans. ITT's other post-retirement benefit obligation was $135 million. The company made $8.2 million in contributions to its global pension obligations during the first nine months of 2015 and expects to make additional contributions in the range of $2 million to $5 million for the remainder of the year.
Fitch's key assumptions within our rating case for ITT include:
--A sales decline of roughly 10% in 2015 followed by low single-digit revenue annual growth;
--EBITDA margin expansion of at least 200 bps over prior year in 2015 with continued moderate expansion through the forecast period;
--Future acquisitions will be funded largely from FCF;
--Moderate dividend growth in the intermediate term with steady shareholder buybacks at current levels;
--Limited additional negative currency effects in the intermediate term;
--Capital expenditures will remain steady in the range of 4% to 5% of revenues, annually.
Fitch is unlikely to consider a positive rating action in the near future given ITT's size relative to its significant asbestos liabilities. Fitch may consider a positive rating action if the company's asbestos liabilities and corresponding expected future cash outlays decline significantly.
Developments that may individually or collectively lead to a negative rating action include:
--A sizable increase in cash outflows associated with asbestos claims due to a large settlement or significant revision of net asbestos liabilities;
--Debt / EBITDA above 1.5x for a sustained period;
-- Total Adjusted Debt/EBITDAR (including net asbestos liabilities) is above 3.0x and FFO Adjusted Leverage (including net asbestos liabilities) is above 3.5x. These adjusted measures partly capture the impact of asbestos liabilities and are not viewed by Fitch as replacing ITT's other credit metrics.
--Debt-funded shareholder-friendly activity.
ITT's liquidity includes $505 million of cash and availability under its $500 million revolver, which will be partially offset by the expected drawing to help fund the WAH acquisition and roughly $11 million of outstanding CP as of Sept. 30, 2015. A majority of ITT's $505 million of cash and equivalents was held in international subsidiaries and although the some of the international cash is not considered indefinitely reinvested outside of the U.S. During the first nine months of 2015 the company made $178 million of net cash transfers from foreign subsidiaries to the ultimate parent, which consisted of $58 million in intercompany loan repayments and $120 million of dividends. ITT renewed its credit facility in November of 2014 and utilizes it to support its CP program.
FULL LIST OF RATING ACTIONS
Fitch has downgraded ITT's long-term ratings as follows:
--Long-term IDR to 'BBB+' from 'A-';
--Senior unsecured bank facility to 'BBB+' from 'A-'.
Fitch has affirmed ITT's short-term ratings as follows:
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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