RPT-Fitch affirms Eaton at 'BBB+'; outlook revised to stable

Thu Sep 26, 2013 8:48am EDT

Sept 26 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has affirmed the Issuer Default Ratings (IDR) at 'BBB+' for Eaton Corporation plc and its indirect subsidiary Eaton Corporation (together 'Eaton'). The Rating Outlook is revised to Stable from Negative. A detailed ratings list follows at the end of this release.

Key Rating Drivers:

The revision of the Rating Outlook to Stable reflects progress toward reducing high leverage that resulted from the $13 billion acquisition of Cooper in November 2012 which was partly funded by debt. In addition, execution risks surrounding the integration of Cooper and the realization of cost synergies, which Eaton now estimates will be slightly higher than originally expected, have diminished. Eaton reduced debt by more than $1 billion during the first half of 2013, which contributed to a reduction in debt/EBITDA to 3.8x at June 30, 2013 compared to 5.1x at the end of 2012.

Leverage as measured at the end of 2012 and through the first three quarters of 2013 is somewhat overstated as it does not fully include the impact of EBITDA acquired with Cooper. Eaton is generally on track with Fitch's expectations for leverage reduction, including an estimated decline in debt/EBITDA to around 3x or below by the end of 2013. This level would still be high for the ratings but should decline further, to 2x or below, within the next two years as Eaton continues to reduce debt and build stronger margins.

Rating strengths include solid market positions in Eaton's electrical and industrial markets, product and geographic diversification, the ability to generate positive free cash flow (FCF) through business cycles, and benefits from the acquisition of Cooper including an expanded product line and opportunities to improve the overall cost structure. Slightly more than half of Eaton's revenue is in the electrical sector, and approximately one-fourth of revenue is in emerging markets. Eaton is exposed to cyclical end-markets including heavy duty trucks, automotive, construction and aerospace, but its exposure is spread across early-, middle- and late-cycles, which tends to lessen the volatility of results.

Rating concerns include the risk of a significant economic downturn which could have a material negative impact on Eaton's credit profile while leverage is high. Other risks include ongoing Meritor litigation and the potential for additional large debt-funded acquisitions. Large acquisitions appear unlikely in the near term while Eaton integrates Cooper and pays down debt. Eaton has integrated previous acquisitions effectively and has realized expected benefits including increased diversification and a broader product line. Meritor litigation involves an antitrust claim against Eaton that originated in 2006. No financial damages, if any, have been determined, but a large award or penalty against Eaton is a possibility when the case is eventually resolved.

Some of Eaton's key end-markets are improving more slowly than anticipated earlier in the year, including U.S. non-residential construction, spending by utilities, heavy duty truck production, and slower growth in Asia. These negative trends are partly offset by increasing electrical demand from data centers, stronger residential construction, and improving global vehicle markets, although European production could be flat or down slightly for all of 2013. The negative impact on margins associated with a slightly weaker outlook could be offset by cost reductions and an increase in Eaton's estimated cost synergies from the Cooper acquisition. Estimated annual tax benefits related to the acquisition of $160 million remain unchanged. Eaton's ability to build stronger margins will be important in supporting FCF and the pace of further debt reduction.

Fitch estimates FCF could exceed $1 billion in 2013 compared to $559 million in 2012 which largely excluded Cooper. Earnings and FCF should benefit from cost improvements related to the integration of Cooper and at Eaton's industrial businesses, partly offset by acquisition integration costs. Fitch expects FCF will be directed primarily toward debt reduction until credit metrics return to stronger levels. In early 2013, Eaton's liquidity benefited from $761 million of cash proceeds from the sale of Apex, a joint venture between Cooper and Danaher. Besides debt reduction, cash deployment includes pension contributions which Eaton estimates will total approximately $300 million in 2013. As of Dec. 31, 2012, domestic and international plans were underfunded by nearly $2 billion (66% funded). The inclusion of Cooper's pension plans (90% funded at the end of 2011) helped to improve the funded status of the combined plans.

Liquidity at June 30, 2013 included $1 billion of cash, most of which was located overseas where it is considered to be permanently reinvested. Although overseas cash is constrained with respect to deployment in the U.S., Fitch views liquidity as adequate when considering Eaton's solid FCF and full availability under three revolvers totaling $2 billion. The facilities have staggered maturities between 2015 and 2017 and are used to back commercial paper. The revolvers and substantially all of Eaton's and Cooper's long-term debt are guaranteed by Eaton Corporation plc and certain of its subsidiaries. Liquidity was offset by $690 million of short-term debt and current maturities. Scheduled maturities of long-term debt include $550 million in 2014 (included in the $690 million of current debt) and $1 billion in 2015. Eaton was in compliance with all covenants at June 30, 2013.

Rating Sensitivities:

An upgrade is unlikely in the near term, but future developments that may, individually or collectively, lead to a positive rating action include:

--Consistently stronger credit metrics through business cycles, including debt/EBITDA near 1.75x and FCF-to-total adjusted debt above 10%;

--An effective integration of Cooper that supports growth in combined market share and an improved competitive position;

--Realization of higher, sustainable margins across the combined company. Future developments that may, individually or collectively, lead to a negative rating action include:

--Slower-than-anticipated reduction in leverage that could result from reduced free cash flow or material discretionary spending for acquisitions or share repurchases;

--A further slowdown in Eaton's end markets that could impair financial results;

--Failure to realize expected acquisition synergies, or unexpected challenges integrating Cooper;

--A material adverse resolution of the Meritor litigation.

Fitch has affirmed the following ratings:

Eaton Corporation plc

--Issuer Default Rating (IDR) at 'BBB+'.

--Senior unsecured bank credit facilities at 'BBB+';

--Short-term IDR at 'F2';

--Commercial paper at'F2'.

Eaton Corporation

--IDR 'BBB+';

--Senior unsecured bank credit facilities at 'BBB+';

--Senior unsecured debt at 'BBB+';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

Cooper U.S., Inc.

--IDR at 'BBB+';

--Senior unsecured debt at 'BBB+'.

The Rating Outlook is Stable.

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