Fitch Ratings has affirmed Honeywell International Inc.'s (HON) Long-
and Short-term Issuer Default Ratings (IDR) at 'A'/'F1'. The Rating
Outlook is Stable. A full list of rating actions follows at the end of
this release.
KEY RATING DRIVERS
Fitch expects HON's leverage will deteriorate modestly following
significant cash deployment in 2015, which included more than $5 billion
of acquisitions and nearly $2 billion of share repurchases. 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.
Debt increased to $12 billion at Dec. 31, 2015 from $8.7 billion at the
end of 2014. As a result, debt-to-EBITDA increased to 1.6x at Dec. 31,
2015 on a preliminary basis (1.5x on a pro forma basis including
acquired EBITDA) compared to 1.24x at the end of 2014. This level is at
the high end of the range incorporated by Fitch in the current ratings
for HON. Fitch believes leverage will decline gradually and remain below
1.5x as HON continues to streamline operations and invest in new product
development.
Concerns about the increase in leverage are 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 estimates FCF/total adjusted debt was 17% in 2015 and 20%
in 2014 and will be steady or increase slightly in 2016 compared to 2015.
Fitch expects EBITDA margins, which increased to nearly 20% in 2015,
will be flat or improve in the near term. HON targets additional margin
improvement across all of its segments although Fitch expects
incremental margin improvement could become more challenging as they are
already at strong levels.
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.
Rating concerns include cash deployment for share repurchases and large
acquisitions that contributed to the $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 concerns 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 due the strong
dollar that 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.
FCF after dividends in 2015 totaled more than $2.6 billion on a
preliminary basis, slightly higher than the previous year. Fitch
estimates FCF will increase slightly again 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 the first nine months of 2015, asbestos payments totaled $150
million, offset by $58 million of asbestos insurance receipts.
Environmental payments were $160 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
expected to contribute $140 million to non-U.S. plans in 2015. Global
plans were well funded at 94% at the end of 2014.
Rating strengths include HON's consistent profitability, solid free cash
flow (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.
KEY ASSUMPTIONS
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 to $7 billion of spending in 2015;
--Sales growth is in the low single digits in 2016 as the positive
effect of organic revenue growth and recent acquisitions are 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 Dec. 31, 2015 (on a pro forma basis for the
Elster acquisition) gradually declines due to earnings growth and
possible debt reduction;
--Cash payments for asbestos and environmental liabilities continue to
be material but manageable.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a
negative rating action include:
--EBITDA margins decline 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%;
--FFO Adjusted Leverage consistently above 3.0x compared to 2.3x at Dec.
31, 2015 on a preliminary basis;
--Debt/EBITDA increases significantly above 1.5x without a clear means
to return to lower leverage;
--An increase in contingent asbestos or environmental liabilities leads
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 Dec. 31, 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 repay commercial paper issued to fund the
acquisition and 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
Dec. 31, 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 has affirmed HON's ratings as follows:
--Long-term IDR at 'A';
--Senior unsecured bank credit facilities at 'A';
--Senior unsecured debt at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
The Rating Outlook is Stable.
HON's outstanding debt totaled $12.1 billion at Dec. 31, 2015.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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