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Fitch Affirms Harris at 'BBB-'; Outlook Positive
April 6, 2017 / 3:51 PM / 8 months ago

Fitch Affirms Harris at 'BBB-'; Outlook Positive

(The following statement was released by the rating agency) NEW YORK, April 06 (Fitch) Fitch Ratings has affirmed Harris Corporation's (HRS) Long-Term Issuer Default Rating (IDR) and long-term issue ratings at 'BBB-', and has also affirmed the Short-Term IDR and commercial paper ratings at 'F3'. The Rating Outlook is Positive. Fitch's ratings cover approximately $4 billion of outstanding long-term and short-term debt after giving effect to the $248 million debt repayment completed in January of 2017. A full list of rating actions appears at the end of this release. KEY RATING DRIVERS The ratings are supported by the company's competitive position in the defense industry; technological capability; good product diversification; adequate liquidity; financial flexibility; and large backlog. The company has solid cash generation and strong operating margins, and it is expected to further improve its operations with the realized cost savings from the acquisition of Exelis Inc. (XLS) completed on May 29, 2015. The Rating Outlook is based on Fitch's expectations that HRS will continue repaying its debt and will reduce leverage over the next three years due to both voluntary and scheduled debt repayments. HRS' leverage metrics will remain adequate for the ratings during the majority of fiscal 2018 despite significant expected debt repayment. Fitch expects the company's leverage (debt/EBITDA) and adjusted leverage (rent adjusted debt/EBITDAR) will decline to approximately 2.2x and 2.5x by the end of fiscal 2018 (ended June 29) following a redemption of the $500 million senior unsecured bonds due in April of 2018. Fitch also expects HRS' FFO adjusted leverage will improve to 3.1x by the end of fiscal 2018, down from 5x at the end of fiscal 2016. As of the last 12 months ended Dec. 30, 2016, the company's leverage and adjusted leverage were 2.9x and 3.2x, down from 4.1x and 4.2x at the end of fiscal year ended July 1, 2015, respectively. HRS has de-leveraged slower than Fitch expected following the XLS acquisition driven by recent portfolio reshaping and share repurchases. The company is on target to meet its earlier commitment of paying down $2 billion of debt by the end of fiscal 2018, but a string of divestitures of several non-core businesses during fiscal 2017 reduced HRS' revenue and EBITDA, resulting in higher than initially expected leverage over the next three years. Fitch estimates the divestitures made during fiscal 2017 will reduce the company's revenue and EBITDA by approximately $1.4 billion and $150 million, respectively, at the end of fiscal 2017. Fitch believes HRS has completed its portfolio reshaping and does not anticipate the company will make additional divestitures or acquisitions in the near future. Even though the company retained higher margin businesses, the decreases in revenue and EBITDA from divestitures will negatively affect HRS' leverage metrics in the short term as the company plans to use a part of the proceeds to repurchase shares and make voluntary pension contributions instead of repaying debt. As a result of the divestitures, Fitch expects HRS' leverage will be approximately 2.7x and 2.2x at the end of fiscal 2017 and fiscal 2018, respectively, revised upwards from the previous projections of 2.4x and 1.9x. Despite slower than initially expected de-leveraging, Fitch views the company's portfolio actions as positive in the long run. Fitch believes the reshaping efforts will result in a stronger operating profile and will enable the company to focus on its more profitable defense businesses going forward. If the company continues to reduce debt, Fitch believes the company's credit metrics will likely be commensurate with a 'BBB' rating by the end of fiscal 2018, as relatively weak leverage metrics for the ratings will be mitigated by strong operating margins and solid cash generation. Fitch expects the company will generate above $800 million of free cash flow (FCF) annually over the next two years before giving effect to dividends of more than $250 million. Fitch expects strong cash generation will support HRS' sizable maturities, as approximately $1.24 billion of debt will mature over the next three years. The majority of the company's non-leverage metrics (profitability, diversity, backlog, etc.) are indicative of a strong investment grade company. HRS is a sole source provider for many of its products and generates solid operating cash driven by strong margins and effective cost management. Fitch expects the company will generate approximately 25% EBITDA margins in fiscal 2017, up from approximately 23% in fiscal 2016, which was negatively impacted by unfavorable product mix and a significant slowdown in commercial end markets. The increase in the estimated 2017 year end EBITDA margin is driven by better product mix due to divestitures of several low margin businesses and merger related synergy savings in the range of $130 million to $135 million. The completion of the XLS integration is expected to result in annual run-rate savings in the range of $140 million to $150 million by the end of fiscal 2018. Fitch is concerned with HRS' exposure to shocks and downturns in U.S. military spending or shifts in spending mix. Fitch still considers the defense outlook to be somewhat uncertain, partly due to the Pentagon's intense focus on lowering costs, which could impact the sector's profitability, as well as the continued risk of sequestration after fiscal 2017. Fitch considers HRS' portfolio to be of good quality, with highly diversified, strategically important, and growing programs. HRS' exposure to U.S. military spending has increased significantly as a result of the broad portfolio reshaping over the last two fiscal years. Since the XLS acquisition, HRS has divested almost all of its commercial businesses including Healthcare Solutions (July 15, 2015), the Composite Aerostructures business (April 8, 2016), and CapRock Communications (Jan. 3, 2017) as well as the Government IT business. Divestitures of commercial businesses decreased HRS' revenue diversification, but this is mitigated by the lower cyclicality and higher margins of the government businesses. Fitch estimates the combined EBITDA margin of the divested businesses was approximately 11% compared to the approximately 25% margin for the remaining portfolio. Fitch is also concerned by HRS' large pension deficit (including a relatively high percentage of Level III assets) and corresponding future pension funding requirements. However, this is mitigated by HRS' plan to make a $588 million contribution to its qualified pension plans during fiscal 2017, including a $400 million discretionary payment to be funded by the divestiture of the Government IT business. Fitch expects the underfunded status of the company's qualified pension plans will improve significantly at the end of fiscal 2017 driven by rising interest rates, expected strong returns of the plans' assets, and the $400 million discretionary contribution. HRS has been de-risking the portfolio of qualified pension plan assets over the past several years, and Fitch expects the trend will continue. In 2016, Level III Assets as a percentage of the pension plan's assets was 22%, down significantly from 30% at the end of fiscal 2015. At the end of fiscal 2016, HRS' pension plans were underfunded by approximately $2.2 billion (approximately 66% funded), a slight deterioration from a $2 billion deficit (69% funded) at the end of fiscal 2015. The pension benefit obligation (PBO) was $6.5 billion at the end of fiscal 2016, while the other postretirement benefit obligation was $311 million (approximately 69% funded). In fiscal 2016, HRS contributed $174 million to its qualified pension plans. The company expects it will not be required to make pension plan contributions in fiscal 2018, fiscal 2019 and fiscal 2020 due to the aforementioned discretionary contribution, however, Fitch assumes HRS will resume contributions in fiscal 2020 at approximately $200 million per year. Fitch believes future funding requirements for the pension obligations are manageable because of the company's strong FCF generation. In addition, the large pension deficit is partially mitigated by the expected reimbursements from the U.S. government, which treats a part of pension costs as allowable and reimbursable costs under some contracts. The projected future cash contributions do not take into account reimbursement the company expects to receive from the U.S. government, and Fitch expects net pension related cash outflows will be lower than the projected contributions. HRS does not disclose the reimbursement amount. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for HRS include: --Flat organic sales in fiscal 2017 and low single-digit revenue growth thereafter; --EBITDA margins at approximately 25% in fiscal 2017 and beyond; --Cash will be deployed towards debt reduction and dividends over the next two years. Fitch expects dividends will increase annually; --The company will not be required to make qualified pension plan contributions over the next two years; -- Fitch expects share repurchases will be limited to offset dilution in fiscal 2018, and additional repurchases will be made from excess cash (if any) remaining after the company retires $700 million of debt by the end of fiscal 2018; --Cash flow generation will be solid and the company will generate approximately $800 million FCF annually before giving effect to pension contributions and dividends; --HRS will not make material debt funded acquisitions over the rating horizon; --Capital expenditures will fluctuate in the range of 2.3% to 2.5% of revenues. RATING SENSITIVITIES Positive: Future actions that may, individually or collectively, cause Fitch to take a positive rating action include continued deleveraging, which would lead to sustained leverage of 2x-2.25x, adjusted leverage below 2.75x, and sustained FFO-adjusted leverage below 3x. Fitch may also consider a positive rating action if faster EBITDA margin improvements translate into better than expected operating results. Negative: Future actions that may, individually or collectively, cause Fitch to take a negative rating action include the company's leverage and adjusted leverage remaining above 2.75x and 3.25x, respectively, for a sustained period of time. Fitch may also consider a negative action if the company's FCF margin declines and remains below 4%. Additionally, a negative action may also be considered if the company engages in sizable share repurchases or acquisitions prior to reducing leverage. LIQUIDITY As of Dec. 30, 2016, HRS' liquidity position was $1.1 billion, composed of approximately $310 million of total available cash and cash equivalents and $825 million of availability under the $1 billion revolving credit facility after giving effect to outstanding LOCs. In its ratings case, Fitch assumes an average of $50 million cash to be restricted and held at foreign subsidiaries for operational purposes. The company's liquidity will likely remain in the range of $1.1 billion to $1.3 billion over the rating horizon as Fitch does not expect HRS' cash balances to fluctuate significantly due to rapid debt repayment. HRS' capital structure consists of senior unsecured credit facilities (comprised of a $1 billion revolving facility and three- and five-year term loans) and senior unsecured bonds. The company has sizable maturities over the next three years as approximately $335 million of outstanding borrowings under the term loans become due in fiscal 2018 and fiscal 2020, the $500 million senior unsecured bonds become due in fiscal 2018, and the $400 million senior unsecured bonds mature in fiscal 2020 (April 2020). Fitch anticipates that HRS will manage the upcoming maturities of senior unsecured bonds with internally generated cash, will repay in full the three-year term loans, and will pay down a significant portion of the five-year term loan by the end of fiscal 2018. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Harris Corporation: --IDR at 'BBB-'; --Senior unsecured revolving credit facility at 'BBB-'; --Senior unsecured three- and five-year term loans at 'BBB-'; --Senior unsecured notes and debentures at 'BBB-'; --Short-term IDR at 'F3'; --Commercial paper at 'F3'. The Rating Outlook is Positive. Contact: Primary Analyst David Petu, CFA Director +1-212-908-0280 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Nicholas Varone Associate Director +1-212-908-0349 Committee Chairperson Craig D. Fraser Managing Director +1-212-908-0310 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings. Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1021774 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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