OREANDA-NEWS. Fitch Ratings has affirmed Cummins, Inc.'s (CMI) Issuer Default Rating (IDR) and long-term debt ratings at 'A'. In addition, Fitch has assigned a short-term IDR of 'F1' and a rating of 'F1' to CMI's planned commercial paper program. The Rating Outlook is Stable.

A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

CMI's commercial paper program will provide additional financial flexibility for short-term funding needs and augments the company's solid free cash flow (FCF) and liquidity. The commercial paper program will be backed by a $1.75 billion revolving credit facility that matures in 2020. At Dec. 31, 2015, CMI's leverage remained at low levels, including debt/EBITDA of 0.6x and funds from operations (FFO) adjusted leverage of 1.4x.

A rating concern is CMI's increased willingness to consider debt-funded acquisitions and higher leverage, including an increase in debt/EBITDA to a range of 1.5x-2.0x, or possibly higher in certain instances. However, Fitch believes an increase in leverage to this level would be temporary and that CMI would use FCF to reduce debt or could adjust its cash deployment to free up funds, including, if necessary, a temporary reduction to its long term plan to return 50% of operating cash flow to shareholders.

CMI's discretionary cash deployment for share repurchases and acquisitions reflects a focus on generating higher growth and returns to shareholders. The company plans to return 50% of operating cash flow to shareholders over the long term but expects to return 75% of cash flow in 2016. The company repurchased $900 million of shares in 2015 and in February 2016 initiated a $500 million accelerated stock repurchase (ASR) program.

Fitch could take a negative rating action if credit metrics were to weaken for a sustained period of one to two years without clear plans by CMI to return them to stronger levels. This could occur if mid-cycle debt/EBITDA is above 1.25x or FCF/Total Adjusted Debt declines to the mid-teens. CMI's leverage would be lower when considering the impact of earnings from manufacturing and distributor joint ventures which are excluded from Fitch's calculation of EBITDA.

The ratings incorporate CMI's competitive positions in its engine and power generation markets, technological capabilities, global distribution network. CMI's low leverage and consistently positive FCF through downturns mitigate risks related to the company's exposure to cyclical heavy- and medium-duty truck, off-road equipment, and power generation markets.

Fitch estimates FCF after dividends for all of 2016 will increase to a range of $650 million - $700 million compared to $589 million in 2015 which was just below the low end of Fitch's previous expectation. FCF declined in 2015 due to higher dividend payments during the year and working capital requirements in the first three quarters, partly offset by positive working capital in the fourth quarter due to a reduction in inventory.

Results in 2016 will be pressured by difficult conditions in several of CMI's key end markets including heavy duty trucks in North America, global mining, oil and gas, and emerging markets including Brazil and China. However, demand for medium duty trucks should be relatively stable. Sales growth in 2016 could decline by high single digits and Fitch expects EBITDA margins will be modestly lower. The impact on profitability and FCF should be mitigated by savings associated with restructuring across all of CMI's segments implemented in late 2015. CMI recognized $90 million of restructuring charges in 2015, and additional restructuring is possible in 2016.

Vertical integration by CMI's truck engine customers, many of whom manufacture engines as well as trucks, represents an ongoing risk. CMI's share of engine sales in the North America heavy duty market could decline further to the low-30% range compared to the high-30% range several years ago as certain customers supply a larger proportion of their own engines and as vertically integrated Europe-based truck makers increase their presence in the U.S. CMI's share of the medium duty truck market in North America is materially higher than heavy duty engines but is subject to similar concerns.

The impact from the loss of market share is partly offset by CMI's expansion in emerging regions, particularly through joint ventures and new product introductions in China that have benefited from trends toward stricter emissions standards, demand for better fuel efficiency and more technology content. New product introductions by CMI's joint ventures and components business in China have supported revenue despite slowing economic growth in the region and lower industry demand. Slower growth in emerging markets, including Brazil, is a continuing concern.

CMI's acquisition activity in the past three years has been centered on purchasing the remaining equity in most of its U.S. and Canadian distributors at a cumulative cost of $783 million. These acquisitions were largely completed in 2015. Full ownership of the distributors should enable CMI to streamline operations and improve customer support. It also provides an opportunity to capture distribution aftermarket revenue from parts, filtration and service which tend to be more stable than CMI's original equipment business.

Joint venture income from unconsolidated ventures, primarily related to the engine and distribution segments, generated approximately 16% of segment profit in 2015. The impact of acquiring and consolidating distributors over the past three years has been partly offset by an increase in income from the Beijing Foton engine joint venture. China should be a source of long-term demand, but there are concerns about government constraints on participation by foreign companies and the near-term impact of recent large declines in industry truck production.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

--North America heavy duty truck production declines by more than 20% in 2016 following a cyclical peak in 2015;
--CMI's engine market share in North America declines gradually due to vertical integration by heavy duty truck OEMs;
--CMI gains additional market share in China, including consolidated and joint venture revenue;
--During 2016, CMI pays approximately 75% of operating cash flow as dividends and share repurchases in the absence of material acquisitions. This level is higher than the company's long term target of 50%;
--FCF of approximately $600 million in 2016;
--Segment EBIT margins decline by approximately 50-75 basis points (bps) in 2016.

RATING SENSITIVITIES

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

--Market share in the North America heavy duty Class 8 truck market deteriorates as a result of customer in-sourcing or competitive pressure, without offsetting gains in other markets;
--CMI loses competitiveness as a result of ineffective new product development;
--Cash deployment for share repurchases or other discretionary spending contributes to consistently higher leverage, including debt/EBITDA consistently above 1.25x;
--Weak FCF resulting in FCF/total adjusted debt declining to the mid-teens compared to levels above 20% historically.

Fitch believes a positive rating action is unlikely given cyclicality in CMI's end markets and the company's willingness to incur additional debt and higher leverage, at least temporarily, to fund future acquisitions.

LIQUIDITY

Liquidity at Dec. 31, 2015 included cash and marketable securities of $1.8 billion. Approximately $1.3 billion of CMI's cash was held outside the U.S., much of which would incur taxes if repatriated. Liquidity is also provided by a $1.75 billion five-year revolver which matures in 2020, most of which was available. Liquidity was offset by $39 million of current maturities of long-term debt and $24 million of loans payable. Debt maturities are spread out, with no significant maturities scheduled before 2023. CMI's debt totaled $1.6 billion at Dec. 31, 2015.

CMI expects to contribute $150 million to pension plans in 2016, compared to $190 million of total contributions in 2015. The plans in both the U.S. and U.K. are overfunded which minimizes the likelihood of large future contributions and supports FCF.

FULL LIST OF RATING ACTIONS

Fitch has affirmed CMI's long-term ratings as follows:

--IDR at 'A';
--Senior unsecured credit facility at 'A';
--Senior unsecured debt at 'A'.

Fitch has assigned short-term ratings as follows:

--Short term IDR 'F1';
--Commercial paper 'F1'.

The Rating Outlook is Stable.