Fitch Rates United Technologies' Planned Sr Unsecured Euro Notes 'A-'; Outlook Stable
KEY RATING DRIVERS
The increase in UTC's debt is in line with Fitch's expectations incorporating the company's cash deployment plans which include \\$16 billion of share repurchases during the three-year period between 2015 and 2017. The company repurchased \\$10 billion in 2015 and plans to repurchase \\$3 billion of shares in 2016. UTC also has a \\$1 billion - \\$2 billion placeholder for acquisitions. Fitch believes additional increases in debt are possible to help fund the company's high cash usage.
Fitch views UTC's cash deployment plans as aggressive, and the company's credit metrics are weak for the ratings. It is possible UTC could exceed some of Fitch's negative rating sensitivities for up to two years or slightly longer. However, there are several considerations that support expectations for an eventual return to stronger metrics.
A key driver of UTC's performance is the company's product positioning in the aerospace cycle, which is contributing to elevated capital expenditures and reduced margins in the near term but should generate solid long-term profitability. Production costs for the Geared Turbofan (GTF) will depress margins at Pratt & Whitney for several years, but as the cost curve improves and aftermarket revenue begins, a large backlog of more than 7,000 orders for GTF engines, including options, will help UTC rebuild market share following a long-term decline associated with legacy engines. GTF engines are on several new aircraft (e.g. A320neo, Mitsubishi Regional Jet, Embraer E190/195-E2 and E175-E2). New program content other than the GTF is provided by UTC's Aerospace Systems segment for the 737MAX, 787-9, 787-10, and A320neo among others.
UTC has also adjusted its strategy for Otis, which generates the highest profit margins among UTC's business segments. UTC intends to rebuild market share in China and Europe and Fitch expects margins could decline slightly in order to build higher market share. The impact would be offset over the long term by increasing Otis' installed base that typically produces high-margin aftermarket business.
UTC's free cash flow (FCF) margin in recent years has been lower than historical levels, partly due to high spending for aerospace development. FCF/total adjusted debt was approximately 11% in 2015. As a result of higher debt levels and margin pressure, Fitch believes UTC will be slow to rebuild FCF/total adjusted debt to stronger levels.
Fitch estimates FCF after dividends in 2016 will be steady compared to more than \\$2.8 billion generated in 2015. Capital spending could be elevated longer than anticipated to support the GTF production ramp and other aerospace programs as well as further restructuring. UTC plans \\$1.5 billion of restructuring during between 2015 and 2018 that would result in \\$900 million of annual savings when completed.
FCF includes the impact of pension contributions. There are no required contributions through 2020 but UTC expects to contribute \\$175 million to global pension plans in 2016. Globally, pension plans were underfunded by \\$4.4 billion at the end of 2015.
Rating strengths include UTC's technological capabilities and competitive positions in key aerospace and building-related markets, product and geographic diversification, a large installed base that supports attractive aftermarket revenue, and relatively stable operating performance and FCF through economic cycles compared to industrial peers. The company has attractive positions on commercial and military aerospace programs and is well positioned to benefit from rising production of commercial aircraft.
Rating concerns include slower growth in China and other developing markets, mixed global construction markets outside the U.S., typical risks associated with aerospace development programs, and negative currency movements that more than offset organic growth in 2015. Large acquisitions could exacerbate UTC's increased leverage although UTC would benefit from acquired EBITDA. If UTC encounters challenges rebuilding market share at Otis or ramping up aerospace production, earnings and cash flow could be weaker than anticipated.
Fitch's key assumptions within the rating case for the issuer include:
--Sales growth in 2016 is flat to slightly positive due to negative currency movements that offset low sales growth in UTC's business segments;
--Aerospace revenue during the next several years benefits from increasing deliveries of engines and systems for new aircraft programs;
--UTC's capital expenditures remain elevated in the near term due to a rapid production ramp for GTF engines and ongoing restructuring;
--Share repurchases of \\$3 billion in 2016;
--Debt increases as a result of UTC's spending for share repurchases and potentially for acquisitions;
--Segment margins decline slightly due to pricing pressure at Otis and negative margins on GTF production.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Execution challenges on the production ramp for the GTF engine that could reduce expected long-term benefits from market share gains and after-market expansion;
--At Otis, a significant loss of market share or persistent deterioration in margins that impairs UTC's overall profitability and FCF;
--Weak operating results or FCF resulting in FCF/total adjusted debt consistently below 10%;
--Sustained shareholder-focused cash deployment results in debt/EBITDA materially above 2.5x, or prevents an eventual improvement in debt/EBITDA below 2.0x. Fitch's definition of EBITDA does not include recurring royalty, joint venture and other income that provide additional modest support to UTC's profitability.
An upgrade is unlikely in the near term given that some of UTC's credit metrics are weak even at the current rating level.
At Dec. 31, 2015, UTC's liquidity included \\$7.1 billion of cash, most of which was located outside the U.S. Liquidity also included \\$4.35 billion of committed bank facilities that mature in 2019. UTC generally has access to foreign cash and typically repatriates a portion which is subject to taxes. The company plans to repatriate \\$1.4 billion during the next two years. Liquidity was offset by \\$1.1 billion of short-term debt, primarily commercial paper. UTC's outstanding debt totaled \\$20.4 billion at Dec. 31, 2015.
FULL LIST OF RATINGS
Fitch rates UTC as follows:
United Technologies Corporation
--Long-term IDR 'A-';
--Senior unsecured bank credit facilities 'A-';
--Senior unsecured notes 'A-';
--Junior unsecured subordinated debt 'BBB+';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
--Long-term IDR 'A-';
--Senior unsecured notes 'A-'.
The Rating Outlook is Stable.