Fitch Maintains Negative Watch on DuPont's 'A' IDR
The Negative Watch reflects the risk that leverage could be elevated following the DowDuPont merger and through the subsequent spin-off (see DowDuPont Merger/Spinoff). Fitch expects DuPont, as currently constituted, will have total Debt/EBITDA of about 2.3x by the end of 2016 before falling below 2x by the end of 2018. In a similar fashion, Fitch expects FFO net leverage to go above 1.5x in 2016 before declining to below 1.5x by the end of 2017.
Roughly $21 billion in securities and facilities, inclusive of the $3 billion revolving credit facility and $5 billion commercial paper (CP) program, is affected.
KEY RATING DRIVERS
Fitch placed DuPont's ratings on Rating Watch Negative on Dec. 11, 2015 following the announcement of the proposed merger of equals between DuPont and Dow Chemical Company. The merger is to be a share-based transaction expected to close in the fourth quarter of 2016, subject to regulatory approval. Subsequent to the merger, DowDuPont Inc. is to be partitioned into three separate public companies. SEC filings indicate that DuPont will be responsible for its finances, will continue to produce financial statements, and that the agricultural business is intended to have a financial profile consistent with DuPont's. Fitch assumes that the Agricultural Company will be the successor to DuPont.
The Agriculture segment accounts for 40%-50% of DuPont's operating income. In the short term, this sector is expected to continue to be challenged by low crop prices, and thus farmer income, as well as tight credit in Brazil. Longer term, Fitch expects the segment to show solid growth from DuPont's strong product portfolio and new product launches.
Weather conditions, food prices, and for corn, ethanol prices, all impact planting and earnings in the short run, resulting in volatility. In addition, the Agricultural segment is highly seasonal with most of the cash flow generated in the fourth quarter and most of the earnings and revenue in the first half of the year.
SUBSTANTIAL FOREIGN OPERATIONS
DuPont has operations in about 90 countries worldwide. While more than two-thirds of 2015 net property by balance sheet valuation was located in the United States, about 60% of revenue is from customers outside of the U. S. The company does hedge certain foreign currency-denominated revenues and occasionally hedges other foreign-currency transactions. DuPont routinely hedges its net exposure related to foreign currency-denominated monetary assets and liabilities by currency. In 2015, net sales were down 7% from 2014 from the strengthening of the U. S. dollar.
As of Dec. 31, 2015, $4.2 billion of the $6.2 billion cash and equivalents and marketable securities on the balance sheet was held outside the U. S. Fitch defines readily available cash as cash on the balance sheet less amounts viewed to be required to run the business or expected to be taxed or distributed to minority interests when repatriated. Fitch estimates $1 billion of DuPont's cash is not readily available.
The company's defined benefit programs were in aggregate 67% funded at the end of 2015. The principal U. S. pension plan was remeasured (discount rate updated to 3.74% from 4.47% at Dec. 31, 2015) in connection with workforce reductions associated with the 2016 cost savings program. The remeasurement increased the U. S. plan's underfunded status by $2.4 billion to about $9 billion. There were no contributions to the main U. S. pension plan in 2015 and the company expects to contribute $230 million to the plan in 2016. Fitch believes that future annual funding requirements for the plan could be in the range of $500 million to $1 billion. Pension funding requirements of the successor to DuPont will be a key consideration of the rating.
DuPont benefits from global reach, end-market diversification, and leading market positions. The company's product portfolio is primarily R&D based and often patent protected, enabling sustainable market advantages and high operating profit margins. The consolidated operating EBITDA margin for 2015 was 18.4%.
Fitch's key assumptions within the rating case for DuPont include:
--Fitch assumes that Dow and DuPont will not provide cross guarantees, there will be no borrowing at the DowDuPont level, and that DowDuPont will not provide a guarantee of Dow or DuPont debt;
--Fitch assumes the Agriculture Company will succeed DuPont and have a credit profile generally consistent with of DuPont as of Dec. 11, 2015;
--$1 billion in cash is assumed to be not readily available to repay debt;
--2016 revenue headwinds as exhibited in the first half, slow growth thereafter;
--Gradual improvement in EBITDA margins given cost-cutting programs reaching about 20% in 2018;
--Capital expenditures to be less than $1.3 billion annually;
--Share buybacks to be less than $2 billion before the merger;
--Aggregate dividends to DowDuPont to be consistent with current levels adjusted for reduced share count;
--Further borrowings under the term loan facility to fund the share repurchases and scheduled debt repayments in 2016.
The Ratings Watch will be resolved when Fitch has further clarity on the operating profile and capital structure of the successor to DuPont.
NEGATIVE: A negative rating action could occur for DuPont or its successor if total debt-to-EBITDA is greater than 2x or FFO-adjusted net leverage is greater than 1.5x on a sustained basis.
POSITIVE: A positive rating action is not expected but could occur for DuPont or its successor if total debt-to-EBITDA is below 1.3x on sustained basis in combination with annual FCF over $1.5 billion on a sustained basis.
Fitch expects liquidity to remain robust. Cash on hand of $4.4 billion as of June 30 2016, full availability under the $3 billion revolver due in 2019 and availability under the $4.5 billion term loan due in 2019 ($500 million drawn at June 30, 2016, remainder available until March 22, 2017) should be more than sufficient to support working capital swings and other operating needs. Fitch expects FCF generation to be greater than $500 million per annum.
In March 2016, the company entered into a credit agreement that provides for a three-year, senior unsecured term loan facility in the aggregate principal amount of $4.5 billion. DuPont may make up to seven term-loan borrowings through March 22, 2017 and amounts repaid or prepaid are not available for subsequent borrowings. The facility matures in March 2019 when repayment is due. As of June 30, 2016, $500 million was outstanding and unused commitments were $4 billion.
Also in March 2016, DuPont amended its existing revolving credit facility to reduce the commitments from $4 billion to $3 billion to reflect lower expected CP borrowings. Both the term loan and the revolver have a maximum total indebtedness-to-total capitalization covenant of approximately 0.66x. The company has been in compliance with the covenant and Fitch expects that it will remain so. Fitch calculates the ratio at about 50% as of June 30, 2016.
In February 2016, the company entered into an on-balance-sheet, $1 billion receivable repurchase facility due to expire on Nov. 30, 2016. Under the facility, the company may sell a portfolio of available and eligible outstanding customer notes receivables within the Agriculture segment to participating institutions and simultaneously agree to repurchase at a future date. The facility was fully utilized as of June 30, 2016.
FULL LIST OF RATING ACTIONS
Fitch has maintained the Rating Watch Negative for E. I. DuPont de Nemours and Company's ratings as follows:
--Long-Term Issuer Default Rating (IDR) at 'A';
--The senior unsecured bank revolver at 'A';
--$4.5 billion term loan at 'A';
--Senior unsecured notes at 'A';
--Senior unsecured debentures at 'A';
--Short-term IDR at 'F1';
--Commercial Paper at 'F1'.
SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS
Fitch has made no material adjustments that are not disclosed within the company's public filings.