OREANDA-NEWS. Fitch Ratings has assigned a 'BBB' rating to Xylem, Inc.'s (XYL) announced EUR500 million senior unsecured notes maturing in 2023.

The issuance is to refinance the $600 million of 3.550% senior unsecured notes coming due in September of this year. Xylem's adjusted leverage (total adjusted debt/EBITDAR) has fluctuated between 2.5x and 2.8x in recent years and was 2.64x on Dec. 30, 2015. Fitch expects the company to maintain adjusted leverage within the range of 2.5x to 3.0x over the medium term. XYL has the ability to increase unadjusted leverage (debt/EBITDA) to as high as 3.5x and remain in compliance with the leverage covenant in its notes and credit facilities. As of Dec. 30, 2015, Xylem's unadjusted leverage was 2.1x.

The Rating Outlook is Stable. A full list of ratings follows at the end of this release. The ratings apply to approximately $1.2 billion of debt.

KEY RATING DRIVERS
Xylem's ratings are supported by its adequate credit metrics, solid liquidity, conservative financial policies and sound margins. The significant aftermarket and replacement equipment content, which account for nearly 40% of revenue, underpins its credit profile. The public utility sector represents roughly one third of the firm's total revenue adding stability to revenue. The company generates stable and steady free cash flows as a result of solid operations, low historical margin volatility, low capital expenditure requirements and the firm's conservative cash deployment strategy. Fitch expects XYL to continue to generate low-single-digit organic growth globally, though operating results may be negatively affected by foreign exchange rates as roughly 60% of sales are generated outside of the U.S. with 35% coming from Europe. XYL does not have material contingent liabilities.

Fitch expects XYL to rely on internally generated cash to fund its balanced cash deployment strategy in 2016 and beyond. The firm's strategy will be focused on capital expenditures, bolt-on acquisitions and shareholder returns in the form of dividends and share repurchases. Fitch anticipates the company's debt levels to remain stable over the medium term as the rating also reflects Fitch's expectation of steady annual dividend growth, meaningful share repurchase and an acquisitive growth strategy.

Revenue generated in 2% of organic revenue in 2015 driven by 4% organic growth in the Public Utility, Commercial and Residential segments respectively. Organic growth in the company's Agriculture segment lagged others with an 8% decline. The company's EBITDA margin remained consistent at approximately 16.6% and Fitch expects XYL will continue to generate favorable margins as the company continues to target $60 million to $75 million of structural cost reductions and lean initiatives over the next several years.

Fitch is concerned that a global economic downturn may hinder operating results as the majority of XYL's products are used to maintain and improve water infrastructure, which is highly dependent on capital spending at the industrial and public level. Weaker demand in XYL's water markets could result in higher-than-expected leverage, though Fitch believes the company would be able to partially offset this with a shift in cash deployment strategies away from shareholder-friendly activities. Additional flexibility comes from Fitch's expectation that XYL will produce roughly $200 million (or 5% of revenue) in FCF (after dividends) through the medium term.

Additional concerns include the negative effects of currency as emerging markets comprised 21% of 2015 revenue, up slightly from the 20% share in 2014. This recent issuance of euro-denominated debt should somewhat mitigate the risks of currency fluctuations to XYL's balance sheet. XYL's currency exposure is further offset by its limited exposure to the most severely-impacted currencies in the world to-date. Xylem's combined exposure to the Middle East, Africa and Latin American is limited as only 10% of revenue is generated in these regions. Further, XYL hedges up to 75% of its net primary foreign currency transactional exposure on a rolling 12-month basis, though translational risk remains.

XYL's net pension obligation was approximately $779 million (72% funded) as of December, 2015. The domestic post-retirement benefit obligation (PBO) totalled only $86 million whereas the international plan represents the lion's share with $693 million in obligations. The company's domestic plan has been closed to new employees since 2011. The company contributed $25 million to its pension and retirement benefits in 2015 and contributed $35 million and $43 million in 2014 and 2013 respectively. Fitch believes that the pension obligations are manageable due to the company's FCF generation.

KEY ASSUMPTIONS
--Low single digit organic revenue growth;
--Moderate annual increases in the size of the dividend;
--Limited future negative impacts from currency fluctuations;
--Continued bolt-on acquisitions with an offsetting reduction in share repurchases in the event of a sizable target.

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

--An increase in adjusted debt/EBITDAR above 3.0x;
--An increase in FFO adjusted leverage above 3.25x on a sustained basis;
--FCF margin below 1.5% for a prolonged period.

Positive: A positive rating action is not likely in the near future given the company's cash deployment policies and cyclicality in some end markets. However, developments that may, individually or collectively, lead to a positive rating action include:

--Adjusted leverage below 2.0x for a sustained period;
--FCF margins above 7% for a prolonged period.

LIQUIDITY
Fitch expects XYL's financial flexibility to remain suitable over the medium term supported by strong liquidity and solid operating cash generation. The company's aggregate liquidity currently stands at approximately $1.2 billion comprised of rising international cash balances and $600 million of availability under its senior unsecured revolving credit facility. Fitch believes that XYL has adequate liquidity and financial flexibility for its ratings despite the fact that a significant portion of its cash is held abroad.

FULL LIST OF RATING ACTIONS

Fitch currently rates XYL as follows:

--IDR 'BBB';
--Senior unsecured notes 'BBB';
--Senior unsecured bank facilities 'BBB';
--Short-term IDR 'F2';
--Commercial paper 'F2'.

The Rating Outlook is Stable.