Fitch Expects to Rate Honeywell's Planned Sr. Unsecured Notes 'A'; Outlook Stable
OREANDA-NEWS. Fitch Ratings expects to assign Honeywell International Inc.'s (NYSE: HON) planned issue of euro-denominated senior unsecured notes, which will include a mix of maturities, a rating of 'A' to. Proceeds will be available for general corporate purposes, including repayment of commercial paper, which totaled $5.9 billion at the end of 2015. The Rating Outlook is Stable. A full list of ratings follows at the end of this commentary.
KEY RATING DRIVERS
HON's leverage deteriorated modestly following significant cash deployment in 2015, which included more than $5 billion of acquisitions and $1.9 billion of share repurchases. Debt increased to nearly $12.1 billion at 31 December 2015 from $8.7 billion at the end of 2014. As a result, debt-to-EBITDA increased to 1.5x at 31 December 2015, which excludes the positive impact of acquired EBITDA, compared with 1.24x at the end of 2014. This level is near the high end of the range incorporated by Fitch in the current ratings for HON. Fitch believes leverage will decline gradually as HON continues to streamline operations and invest in new product development.
The increase in leverage is offset by strong free cash flow (FCF) and a high level of liquidity, which provides financial flexibility to fund discretionary spending and cope with cyclical end markets. Fitch expects EBITDA margins, which increased to nearly 20% in 2015, will be flat or improve in the near term although HON targets additional margin improvement across all of its segments.
Margins improved by more than 500 bps during the past four years, roughly half of which occurred in 2015, due to a better product mix, partly achieved through acquisitions and divestitures, ongoing operating improvements, and restructuring which HON estimates will reduce costs by at least $150 million in 2016. Margin growth in the Aerospace segment is partly offset by the negative near-term impact of incentive costs related to HON's content on new platforms.
At the end of 2015, HON acquired the Elster division of Melrose Industries for approximately $5 billion. Elster generates favorable EBITDA margins of over 20% and will be integrated with HON's Automation and Controls Solutions and Performance and Materials and Technologies segments.
Rating weaknesses include cash deployment for share repurchases and large acquisitions that contributed to a $3.4 billion increase in HON's debt during 2015. In addition to the acquisition of Elster, HON repurchased shares totaling $1.9 billion in 2015. Fitch expects share repurchases and acquisitions in 2016 will be substantially below the amount of $7 billion in 2015. HON should generate sufficient FCF, however, to fund a modest level of discretionary spending without increasing debt.
Other risks include the negative impact of currency exchange rates on results, difficult conditions in oil and gas markets, slow global economic growth, and ongoing cash payments related to asbestos and environmental liabilities. HON's revenue fell 4% in 2015 as the strong dollar more than offset organic growth across most of the company's businesses. Currency likely will pressure sales again in 2016 although HON has hedged a large part (85%) of its exposure to the euro.
HON's exposure to oil and gas is concentrated in its UOP and Process Solutions businesses where Fitch expects revenue will remain challenged. However, the impact is mitigated by the substantial portion of aftermarket services in these businesses, and HON's total oil and gas exposure is limited to approximately 11% of revenue.
Fitch estimates FCF will increase slightly in 2016 to $2.7 billion, including the impact of the Elster acquisition. FCF reflects the company's steadily improving margins, modest pension contributions, and ongoing asbestos and environmental payments, partly offset by higher dividends and capital expenditures. Capital expenditures could remain higher than in the past as HON invests in product development and production capacity across its businesses.
In 2015, asbestos payments totaled $209 million, partly offset by $63 million of asbestos insurance receipts. Environmental payments were $273 million. Asbestos and environmental payments are likely to continue for an extended period due to the nature of the liabilities. The amount of annual payments related to NARCO was capped at $140 million under a trust established in 2013, excluding certain one-time payments. Pension contributions are primarily related to non-U.S. plans. HON did not make contributions to its U.S. pension plans in 2015 and does not plan to make contributions in 2016. It expects to contribute $160 million to non-U.S. plans in 2016. Global plans were well-funded at 95% at the end of 2015.
Rating strengths include HON's consistent profitability, solid FCF, diversification across product and geographic markets, and substantial liquidity. The company has a well-positioned product portfolio that includes high technology content with broad applications in aerospace and defense, industrial processes, and controls used in buildings. Recently announced or completed acquisitions should strengthen HON's market positions and further support the company's margins, which have improved steadily despite slow sales growth.
Fitch's key assumptions within the rating case for the issuer include:
-Spending for acquisitions and share repurchases in 2016 is reduced by more than half compared with $7 billion of spending in 2015;
-Sales grow by low single digits in 2016 as the positive effect of organic revenue growth and recent acquisitions is offset by negative foreign currency movements;
-EBITDA margins increase only slightly in 2016. Significant margin improvement after 2016 is not assumed by Fitch although there is room for increases in each of HON's segments under the company's long term targets;
-FCF in 2016 increases to approximately $2.7 billion from $2.6 billion in 2015;
-Debt/EBITDA of 1.5x at 31 December 2015 gradually declines due to earnings growth and possible debt reduction;
-Cash payments for asbestos and environmental liabilities continue to be material but manageable.
Future developments that may, individually or collectively, lead to a negative rating action include:
-EBITDA margins declining consistently below a level in the mid-teens compared to nearly 20% in 2015 and 17.4% in 2014;
-FCF-to-total adjusted debt below 10%;
-Funds from operations (FFO) adjusted leverage consistently above 3.0x;
-Debt/EBITDA increasing significantly above 1.5x without a clear means to return to lower leverage;
-An increase in contingent asbestos or environmental liabilities leading to significantly higher annual cash payments.
Future developments that may, individually or collectively, lead to a positive rating action include:
-Consistently strong FCF, defined as FCF-to-total adjusted debt near 25% or higher;
-A material reduction in leverage, including debt/EBITDA near 1.0x or below;
-A long-term reduction in asbestos and environmental liabilities;
-Further margin expansion.
LIQUIDITY AND DEBT STRUCTURE
Liquidity at 31 December 2015 included nearly $5.5 billion of cash in addition to short-term available-for-sale investments. Much of HON's cash is located outside the U.S. which would reduce the company's effective liquidity modestly after the impact of potential taxes on repatriated earnings. However, foreign cash is available to fund overseas acquisitions as occurred with Elster.
Liquidity also includes a $4 billion credit facility that matures in 2020. A $3 billion 364-day facility was put in place prior to the Elster acquisition and is subject to mandatory reductions following HON's completion of financing used to repay commercial paper issued to fund the acquisition and to repay $1.1 billion of debt maturing in November 2015 and March 2016.
Liquidity was offset by $5.9 billion of commercial paper outstanding at 31 December 2015 and $577 million of long-term debt maturities. Long-term debt maturities after 2015 are well distributed and do not exceed $900 million in any single year.
FULL LIST OF RATING ACTIONS
Fitch's ratings for HON are as follows:
-Long-term IDR 'A'; Stable Outlook
-Senior unsecured bank credit facilities 'A';
-Senior unsecured debt 'A';
-Short-term IDR 'F1';
-Commercial paper 'F1'.
HON's outstanding debt totaled nearly $12.1 billion at 31 December 2015.