TEXT-Fitch affirms Xylem 'BBB' issuer default rating
Oct 26 - Fitch Ratings has affirmed Xylem Inc.'s (XYL) Issuer Default Rating (IDR) and senior unsecured notes at 'BBB', and its Short- term IDR at 'F2'. The Rating Outlook is Stable. Approximately $1.2 billion debt is affected by the affirmation. A full list of ratings follows at the end of this release. The ratings are supported by XYL's solid liquidity, strong margins and good operating performance including solid cash generation. The company's margins are bolstered by sizable aftermarket and replacement equipment content which account for nearly 40% of revenues. Fitch notes that XYL does not have material contingent liabilities and has conservative financial policies which include its commitment to maintaining investment grade ratings. XYL is a market leader in several highly fragmented niche markets of the global water industry, specializing in such highly engineered and technology intensive areas as waste water transport, treatment and testing. The company also provides industrial and real estate markets with heat exchangers, valves and boiler controls, among other products. The company is expected to actively pursue small to medium sized bolt-on acquisitions within its markets, however Fitch does not anticipate XYL making a large debt financed acquisition. XYL is well diversified by its exposure to various end markets and geographically. In 2011, the company derived the majority of its revenues from Industrial (including oil & gas, power, chemical, and mining end-markets) and Public Utility sectors, while also participating in commercial and residential real estate and agriculture. During last year, its geographic mix by revenue was 37% in Europe, 36% in the United States, 11% within the Asia Pacific region, and 16% in other areas. Fitch expects XYL's revenue to be relatively flat in 2012 and increase in 2013. Fitch expects the company's margins to remain strong allowing the company to generate approximately $200 million to $250 million of free cash flow (FCF - cash from operations less capex less dividends) after dividends over the next several years. Fitch anticipates XYL to maintain strong operating margins due to strong competitive position and large aftermarket and replacement product content. Fitch's concerns include: --XYL's exposure to cyclicality of its end market, particularly industrial sector and commercial and residential real estate, somewhat mitigated by large aftermarket content and solid product and geographic diversification; --Anticipated large discretionary spending for acquisitions and ensuing integration risks; and --Weaker than anticipated demand in XYL's water markets in 2012, mainly driven by challenging economic conditions in Europe. At June 30, 2012, XYL had solid liquidity of $958 million comprised of $358 million in cash and full availability under its $600 million revolving credit facility. A large portion of XYL's cash is located outside the U.S. to fund international operations. Fitch expects the company's leverage (debt to EBITDA) to be approximately 1.9x at the year-end 2012, unchanged from 2011. The leverage is expected to gradually decline over the next several years driven by the anticipated organic and acquisitive sales growth. XYL has the ability to increase its leverage and remain in compliance with the covenants of its debt and credit facilities. After the spin-off from ITT Corporation (ITT), XYL assumed approximately $400 million, or approximately 6%, of ITT's pension obligations. As of Dec. 31, 2011, XYL's pension liabilities totaled $670 million with a pension deficit of approximately $253 million (62% funded). The other postretirement benefit obligation was $272 million. The defined benefit plan is now closed to new employees after the spin-off. As of June 31, 2012, XYL had already contributed $19 million to its qualified pension plans. The company plans to contribute an additional $15 to $20 million for the remainder of the year. Fitch believes XYL's pension obligations are manageable due to the company's solid FCF generation. FUTURE RATING ACTIONS Fitch may consider a positive rating action if the company gradually reduces its leverage and can demonstrate its ability to weather a significant economic downturn as a pure play water company. Fitch may consider a negative rating action if XYL's sales and margins decline significantly, resulting in weaker leverage metrics without an expected recovery in 12 to 18 months. Fitch may also consider a negative rating action if the company makes a large debt funded acquisition. Fitch affirms XYL's ratings as follows: --IDR at 'BBB'; --Senior unsecured bank facilities at BBB'; --Short Term IDR at 'F2'; --Commercial Paper at 'F2'. Rating Outlook is Stable.
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