Fitch Ratings has affirmed Honeywell International Inc.'s (NYSE: HON) long-term and short-term ratings at 'A/F1' and revised the Rating Outlook to Stable from Negative. The revised Rating Outlook reflects Fitch's diminished concerns about pressure on HON's operating performance and credit metrics as the company's end-markets recover. In addition, HON maintains conservative financial policies that should support modest improvement in its credit metrics. Leverage at March 31, 2010 remained somewhat weak for the ratings, including debt to EBITDA of 1.6 times (x). However, the deterioration in leverage during the economic downturn was limited despite a 15% decline in sales in 2009.
The ability to maintain steady margins and strong free cash flow through the recession demonstrates the improvement in HON's operating flexibility compared to the previous recession when it incurred losses. In addition, the company has used available cash to reduce debt from peak levels reported in 2008 and further debt reduction is possible. It has made significant stock contributions to its underfunded pension plans and refrained from share repurchases. Discretionary spending, especially acquisitions, is likely to be a material use of cash going forward due to HON's expected large free cash flows in future years. However, Fitch believes such expenditures will be sufficiently controlled to maintain leverage and other financial measures at levels consistent with HON's current 'A/F1' ratings. Fitch estimates that debt/EBITDA could be steady in 2010 due to higher non-cash pension expenses. When excluding pension expense, debt/EBITDA could be less than 1.4x by the end of 2010 compared to 1.55x at the end of 2009.
Cash deployment for special items such as asbestos, environmental, and pension liabilities is an important consideration for HON's financial flexibility and liquidity. The company generates sufficient cash flow to fund these items, but such spending reduces cash available for other purposes. Total expenditures for special items, excluding repositioning, totaled approximately $600 million in 2009 and have generally remained in a stable range although large fluctuations are possible. In 2010 HON anticipates that net asbestos payments could increase to roughly $650 million, compared to net payments of $140 million in 2009, due the possible funding of the NARCO trust. However, the trust has been delayed repeatedly and the timing remains uncertain. Environmental expenditures continue to be around $300 million annually but are expected to decline gradually after 2010, due partly to HON's recent efforts to resolve both asbestos and environmental liabilities. These efforts contributed to a reduction during 2009 of a large number of inactive asbestos claims. Future payments will remain material but should gradually decline over time.
Pension liabilities represent a rating concern due to potentially large contributions. HON's net pension liability increased significantly in 2008 and 2009 to $4.1 billion due to negative asset returns and changes in discount rates. As a result, HON estimates non-cash pension expense will increase to $820 million in 2010 and $900 million in 2011. The company has addressed the liability by contributing $940 million of stock during the past two years, not including smaller contributions to its non-U.S. plans. The company plans to make additional contributions of at least $400 million of common stock in 2010 plus $150 million in cash to non-U.S. plans. Fitch anticipates that HON will continue to focus on minimizing its pension, asbestos and environmental liabilities through additional contributions and the resolution of litigation where possible.
In addition to expenditures for special items, HON has consistently implemented repositioning programs to improve the efficiency and cost structure of its manufacturing and back-office operations. The programs contributed to HON's ability to sustain margins through the recent economic downturn. Annual cash expenditures for repositioning typically range up to $200 million and could even increase slightly in 2010. The company's steady margin performance and continued product development should provide a sound base for maintaining or growing market share as the economy improves. Margins should benefit further from a gradual increase in sales volumes but some of the improvement is likely to be negated by the reversal of temporary cost cuts in 2009.
Sales growth in 2010 could be in the low single digits. Growing orders in several short-cycle businesses, including Turbo Technologies and certain parts of the Automation and Controls segment, are expected to be partly offset by weak conditions in late-cycle aerospace and non-residential construction. The turnaround in Turbo Technologies is consistent with other parts of the automotive industry that are recovering from an unusually deep trough in demand. HON's aerospace aftermarkets remain weak but could improve later in 2010 as passenger traffic returns, but regional and business jet markets may be weak into 2011.
Other rating concerns include ongoing risks related to the timing of a complete recovery in HON's aerospace and non-residential construction markets and the impact of future acquisitions on the company's leverage. HON currently has two pending acquisitions totaling more than $1.5 billion, including Sperian for $1.4 billion, but the company has sufficient cash to fund them without impairing its liquidity. Sperian makes personal protection equipment and complements HON's Safety Products business. Integration risks are mitigated by HON's demonstrated ability acquire and integrate previous acquisitions.
The completion of HON's two pending acquisitions will reduce liquidity, but HON can be expected to generate roughly $2 billion of free cash flow after dividends in 2010. This level would be slightly less than 2009 when HON experienced lower working capital requirements and a temporary reduction in capital expenditures. Cash flow should benefit from incremental earnings from pending acquisitions, operating and working capital improvements from restructuring, and cost efficiencies related to sales growth. HON's liquidity will also depend on future acquisitions, cash contributions to pension plans, and payments required for asbestos liabilities and environmental remediation. Liquidity at March 31, 2010 included $2.8 billion of cash and a $2.8 billion credit facility that matures in 2012, offset by $1.3 billion of debt, primarily commercial paper, due within one year. HON also has a securitization program that was unused as of March 31, 2010.
Fitch has affirmed the following ratings for HON:
--Issuer Default Rating (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 ratings affect approximately $7.6 billion of debt outstanding as of March 31, 2010.
Applicable criteria are available at 'www.fitchratings.com' and specifically include:
--'Corporate Rating Methodology' (Nov. 24, 2009).
Additional information is available at 'www.fitchratings.com'.
Eric Ause, +1-312-606-2302 (Chicago)
Cheryl Peterson, +1-212-908-0310 (New York)
Cindy Stoller, +1-212-908-0526 (New York)
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