TEXT-S&P affirms Precision Castparts 'A-/A-1' ratings
Overview -- Precision Castparts plans to acquire Titanium Metals Corp. for $3 billion, funded almost entirely with debt, which will result in a significant deterioration in the firm's currently very strong credit protection measures. -- We are affirming our ratings on the aerospace supplier, including the 'A-' corporate credit rating and 'A-1' short-term rating. -- The stable outlook reflects our expectations that the strong commercial aerospace market and the company's solid history of integrating and improving acquisitions should result in credit ratios consistent with the rating over the next 12-18 months. Rating Action On Nov. 12, 2012, Standard & Poor's Ratings Services affirmed its ratings on Precision Castparts Corp., including the 'A-' long-term corporate credit rating and 'A-1' short-term corporate credit rating. The outlook is stable. Rationale The ratings on Precision Castparts reflect our expectations that credit ratios, which will decline materially from currently very strong levels following the proposed acquisition, will return to levels more appropriate for the ratings over the next 12-18 months. Precision Castparts recently announced that it plans to acquire Titanium Metals Corp. (Timet; not rated) for approximately $3 billion (including about $100 million in outstanding debt), which we expect will be funded almost entirely with debt. Our current ratings had incorporated the possibility of an acquisition of this magnitude. The company has arranged for a $3 billion committed bridge facility but said it expects that the acquisition will ultimately be funded through a combination of cash on hand, commercial paper, bank debt, and proceeds from the sale of notes and bonds. The company expects to complete the acquisition by the end of 2012. The increased debt from the acquisition, the company's largest, will result in credit ratios declining materially from currently very strong levels. We believe that pro forma fiscal 2013 (ending March 31, 2013), assuming no further acquisitions, debt to EBITDA will increase to about 1.3x from our previous expectations of below 0.5x, debt to capital will increase to above 25% from 5%, and funds from operations (FFO) to debt will decline below 50% from more than 250%. However, we expect that the strong commercial aerospace market and the company's very successful history of integrating and improving acquired operations should result in credit ratios returning to levels more appropriate for the rating, notably FFO to debt above 60%, by the end of fiscal 2014, supporting our "minimal" financial risk profile assessment. Timet produces titanium and titanium alloys for commercial aerospace (63% of 2011 sales), industrial (17%), military (13%), and other markets (7%). Timet is a key supplier to Precision Castparts (16% of 2011 sales were to Precision Castparts). The acquisition will allow Precision Castparts to have more control over its titanium supply and increases the company's exposure to the strong commercial aerospace market. The acquisition will improve Precision Castparts' competitive position modestly, but not enough to change our already "satisfactory" business risk assessment. Timet's EBITDA margins are about 20%, below Precision Castparts' close to 30% margins, but Precision Castparts has a consistent history of improving margins at acquired operations, so it wouldn't be surprising if they approach the current corporate average in a few years. The acquisition increases the company's exposure to sometimes-volatile metal prices, which could affect margins. Liquidity The short-term rating is 'A-1'. We believe Precision Castparts' liquidity will remain "exceptional" pro forma for the proposed acquisition. We believe that sources of liquidity will exceed uses by at least 2x in the next two years, the minimum we require for the exceptional designation. We also expect that sources would exceed uses even if EBITDA were to decline by 50%. As of Sept. 30, 2012, cash and equivalents were $193 million. The company often uses commercial paper (CP) to temporarily fund acquisitions and about $444 million of CP was outstanding as of Sept. 30, 2012. The company generated about $455 million of free cash flow in the first six months of fiscal 2013 and we believe free cash flow for the full year will exceed $1 billion, up from $850 million in 2012, mainly as a result of higher earnings driven by the strong commercial aerospace market and the contribution from acquisitions. We expect the company to use its excess cash generation and borrowing capacity for acquisitions. Precision Castparts made six acquisitions in the first half of 2013 for a total of $1.4 billion. A $1 billion unsecured revolving credit facility ($555 million available as of Sept. 30, 2012) maturing in November 2016 supplements Precision Castparts' internal liquidity and serves as backup for any CP outstanding. The company has a substantial cushion under the leverage covenant in the facility, which limits debt to capital, as defined, to 65% (6.8% actual as of Sept. 30, 2012). We expect that the cushion will likely be less, but still substantial, after the Timet acquisition. Debt maturities are minimal in fiscal 2013, and a manageable $200 million is due in fiscal 2014. The company has not stated what the permanent financing for the Timet acquisition will be, but we expect debt maturities to remain manageable. The company pays a small dividend and has historically not repurchased shares. Outlook The outlook is stable. Although credit ratios will be depressed following the proposed transaction, we believe substantial free cash flow, solid demand from the strong commercial aerospace market, and the company's demonstrated ability to successfully integrate acquisitions should enable it to restore credit measures to levels more appropriate for the rating in the next 12-18 months. However, the transaction reduces the room in the current rating for further large debt-financed acquisitions. We could lower the rating if further large debt-financed acquisitions, a material deterioration in the commercial aerospace market, or integration problems result in FFO to debt that we expect to remain below 55% at the end of fiscal 2014. We could lower the short-term rating to 'A-2' if large acquisitions cause us to revise our assessment of liquidity to "strong." We are unlikely to raise the ratings following the recent transaction because of the likelihood of further acquisitions and the cyclical nature of the markets the company serves. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Standard & Poor's Standardizes Liquidity Descriptors for Global Corporate Issuers, July 2, 2010 -- Key Credit Factors: Methodology And Assumptions On Risks In The Aerospace And Defense Industries, June 24, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed Precision Castparts Corp. Corporate Credit Rating A-/Stable/A-1 Senior Unsecured A- Commercial Paper A-1 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. 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