TEXT - Fitch affirms Textron ratings
Nov 19 - Fitch Ratings has affirmed the Issuer Default Rating (IDR) and long-term debt ratings for Textron Inc. (TXT) and Textron Financial Corporation (TFC) at 'BBB-'. The Rating Outlook for both is Stable. In addition, TXT's short-term ratings have been affirmed at 'F3'. A full rating list follows at the end of this release. TXT's ratings reflect the company's well-established market positions in its aerospace, defense and industrial businesses; improved liquidity; positive annual free cash flow (FCF); and improving risk profile at TFC which continues to exit its non-captive portfolio. Debt/EBITDA at TXT's manufacturing businesses declined to 1.9x at Sept. 29, 2012 from 2.1x at the end of 2011 and nearly 2.4x at the end of 2010. Leverage and other credit metrics could improve further as performance at TXT's manufacturing businesses improves over the long term. The possibility of a positive rating action is reduced in the near term by concerns including pressure on U.S. defense spending, which is an important part of the Bell and Textron Systems businesses, low unit deliveries and margins at Cessna, execution problems on several unmanned aerial programs at Textron Systems, and expectations for weaker demand in Kautex's automotive markets in Europe and Asia. These concerns are exacerbated by uncertainty surrounding the fiscal cliff and the effect of possible sequestration on defense spending. If the U.S. addresses these fiscal issues effectively in the near term, visibility could improve in TXT's aerospace and defense related businesses. The possible favorable impact of improved visibility, combined with TXT's priority for debt reduction (approximately $500 million is scheduled to mature in the first half of 2013), could potentially lead to a positive rating action in the next few quarters. Fitch estimates FCF after dividends could improve to a range of $400 million - $500 million in 2012 compared to $311 million in 2011. The increase largely reflects substantially lower pension contributions. FCF was slightly negative through the first nine months of 2012, reflecting lower advance payments on military contracts related to timing, and higher used-business-jet inventory due to trade-ins. FCF could be strong in the fourth quarter and will depend on business jet deliveries, which can be seasonal, and on an improvement in the pace of advance payments on military contracts. FCF could be lower than expected if the tepid recovery in demand for business jets limits deliveries. TXT contributed $642 million to its pension plans in 2011 and $181 million through the first nine months of 2012. The company plans to contribute a total of $200 million in 2012. At the end of 2011, the pension deficit was $1.3 billion (79% funded). TXT estimates the unfunded position will be stable at the end of 2012 as contributions offset the negative impact of a lower discount rate. Other uses of cash include product development expenditures at Cessna and Bell, and the possible resumption of higher dividend payments which have been low for several years while TXT addressed challenges at TFC's non-captive portfolio. Also, acquisition activity has been modest for several years but has the potential to increase. At Cessna, deliveries of business jets are up modestly from the previous year, but the business jet recovery has been slower than anticipated. Demand is weakest in the light end of the business jet market where Cessna's deliveries are concentrated, and the market could be weak through much of 2013. As a result, Cessna's backlog has declined to $1.3 billion, increasing the risk that Cessna could cut production if orders weaken further. Margins are low due to weak sales, pricing pressure, and product mix, including recent sales of used jets, which typically generate little profit. Helicopter sales at Bell are benefiting from a recovery in demand for commercial helicopters, with segment revenue up more than 20% through the first three quarters of 2012. Concerns about military spending are mitigated by Bell's position on the H-1 and V-22 aircraft programs where deliveries should be generally stable through 2014. Also, Bell has a substantial installed base which could benefit from aftermarket spending and modernization programs. At Textron Systems, results are likely to be negatively affected by delays in certain programs and by execution challenges on unmanned aerial programs that could depress margins for several quarters before they are fully resolved. However, Textron Systems provides a broad mix of products that reduces exposure to single programs. TXT's Industrial segment performance has improved modestly during 2012, but the automotive fuel systems business could be challenged in the near term by lower automotive production in Europe and lower sales by Japanese OEM customers in China. The Industrial segment's golf and turf markets have begun to improve; construction remains weak but could potentially benefit from the beginning of a recovery in residential construction. At Sept. 29, 2012, TXT's liquidity included manufacturing cash of $1.2 billion and a $1 billion four-year bank facility that expires in 2015. The facility includes a maximum debt to capitalization covenant of 65% and a requirement that TFC's leverage not exceed 9:1. Fitch calculates these covenants were well within compliance. Manufacturing cash balances could increase by the end of 2012 if TXT generates strong seasonal FCF in the fourth quarter. Liquidity is offset by scheduled debt maturities at TXT's manufacturing business, including EUR239 million of notes due in March 2013 and $215 million face value of convertible notes due in May, including debt discount. The amount of convertible notes excludes approximately $214 million conversion value of the notes which TXT may pay in cash or shares. There are no other material debt maturities owed by the manufacturing business until 2015. Liquidity is also affected by TXT's support for TFC through capital contributions and intercompany loans. However, TFC's liquidity has been sufficient to pay dividends to TXT in excess of capital contributions. TFC has also repaid much of the intercompany loans during 2012 previously borrowed from TXT. Fitch expects future support for TXT, net of dividends, to be minimal although loans may be required temporarily in 2013 to help fund TFC's scheduled debt maturities. TFC's non-captive portfolio was less than $500 million at Sept. 30, 2012. Fitch views positively the progress TFC has made in liquidating the non-captive portfolio, but believes risks remain. Asset quality for the first nine months of 2012 improved as non-accrual finance receivables declined 55% from Dec. 31, 2011. However, golf mortgage receivables, which typically have 20+ year maturities, continue to account for the largest portion of the portfolio. Cash collections on liquidated receivables have supported a reduction in debt. However, if cash generated from the liquidation of TFC's non-captive portfolio is less than expected as a result of higher credit losses or discounting, TXT would need to provide further support to TFC. TFC's leverage was 3.4x at Sept. 30, 2012, as estimated by Fitch, compared to 4.5x at the end of 2011 and 4.8x at the end of 2010. Fitch believes the amount and timing of some of TFC's debt maturities and asset liquidations in 2013 could be mismatched and expects TFC may borrow against the intercompany facility to repay a portion of its 2013 debt maturities. However, Fitch expects the impact on TXT will be limited as TXT has sufficient cash balances and operating cash flow to support TFC at its current size. Fitch's concerns about liquidity should decline as the non-captive portfolio shrinks further. TFC's captive portfolio totaled $1.7 billion at Sept. 30, 2012, and consisted primarily of aviation receivables. Non-accrual accounts were 5.5% of total captive receivables at Sept. 30, 2012 compared to 7.0% at the end of fiscal 2011. Although the level of non-accrual accounts is relatively high, potential concerns about credit quality in the captive portfolio are mitigated by an improving trend in the level of accruals and TFC's expertise managing aviation receivables. Fitch could take a positive rating action if Cessna's business jet market improves materially, TXT adjusts effectively to lower defense-related revenue at Bell and Textron Systems, net pension liabilities are reduced, and TFC continues to liquidate the non-captive portfolio successfully. Also, the repayment of approximately $500 million of near-term debt maturities in 2013 would further reduce leverage and support a positive rating action. The ratings could be negatively affected if TFC requires material support from TXT in excess of temporary support anticipated by Fitch during 2013, revenue and margins at the manufacturing businesses are impaired by an economic downturn, or spending for acquisitions or other discretionary uses significantly reduces TXT's liquidity. TFC's ratings are equalized with TXT's ratings as Fitch believes TFC is a core subsidiary to its parent as illustrated through a support agreement and other factors. The support agreement requires TXT to maintain full ownership, minimum net worth of $200 million and fixed-charge coverage of 1.25x. Other factors supporting the rating linkage include a shared corporate identity, common management, and the extension of intercompany loans to TFC. Fitch has affirmed the ratings for TXT and TFC as follows: TXT --IDR at 'BBB-'; --Senior unsecured bank facilities at 'BBB-'; --Senior unsecured debt at 'BBB-'; --Short-term IDR at 'F3'; --Commercial paper at 'F3'. TFC --IDR at 'BBB-'; --Senior unsecured debt at 'BBB-'; --Junior subordinated notes at 'BB'. Approximately $4.1 billion of debt outstanding at Sept. 30, 2012 is affected by the ratings, including nearly $2.4 billion at TXT and $1.7 billion at TFC. Contact: Textron Inc.