August 29, 2017 / 7:35 PM / 10 months ago

Fitch Affirms Johnson Controls at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, August 29 (Fitch) Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDR) and Long-Term debt ratings for Johnson Controls International plc (JCI) and Tyco International Holding S.a.r.l. (TSARL) at 'BBB+'. The Short-Term IDR and Commercial Paper Ratings for JCI and TSarl have been affirmed at 'F2'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release. KEY RATING DRIVERS Rating Strengths: The ratings for JCI consider the company's strong market positions within its fragmented building, fire and security markets; a leading global market position for automotive batteries in the Power Solutions business; and larger scale and broader technological capabilities associated with the integration of Tyco acquired last year. Other rating strengths include meaningful service and aftermarket revenue that mitigate cyclicality and minimal limitations on available cash associated with the company's Irish domicile. Weak Leverage and Cash Flow: Leverage and free cash flow (FCF) are currently weak for the 'BBB+' rating and weaker than expected by Fitch following the Tyco acquisition and spin-off of Adient in the last half of calendar 2016. Debt as of June 30, 2017 was $14.3 billion; a level that Fitch anticipates will decline by roughly $1 billion in the fourth quarter as JCI generates positive FCF. Fitch originally expected debt would decline to the mid-$11 billion range by the end of fiscal 2017, a reduction that now appears likely to occur in fiscal 2018 when Fitch expects JCI will generate positive FCF as well as approximately $1.8 billion of after-tax cash proceeds from the divestiture of Scott Safety. Fitch expects proceeds will be largely deployed to reduce a $3.9 billion term loan at TSarl. FCF in 2017 has been more negative than anticipated by Fitch due to large transaction tax payments; higher-than-anticipated cash costs for restructuring, integration and transactions; and an increase in working capital requirements, primarily higher inventory levels at the Power business to support sales. FCF typically is strongest in the fourth quarter, and Fitch estimates full-year FCF after dividends in 2017 could be approximately negative $2.2 billion-$2.3 billion compared to negative $2.9 billion in the first nine months. Fitch estimates FCF could improve in 2018 to more than $1 billion due to a decline in one-time tax and transaction-related expenditures incurred in 2017, tax credits related to Adient, lower costs from restructuring, and tax and cost synergies associated with the integration of Tyco. FCF should also benefit from improvements in working capital in the Power Solution business and as JCI integrates Tyco, with the company targeting a reduction of approximately $500 million through 2018. Leverage Metrics: Fitch estimates debt/EBITDA at the end of fiscal 2017 will be slightly below 3.5x and will improve to a range of 2.5x - 3.0x by the end of fiscal 2018. Fitch estimates FFO adjusted leverage could decline below 3.5x by the end of fiscal 2018. Other than leverage, Fitch believes some of JCI's characteristics, such as diversification and the overall operating margin when considering expected improvements, could be consistent with 'A' category ratings over the long term. Rating Concerns: Rating concerns include typical integration risks associated with the Tyco merger and restructuring costs to realign the combined company. Integration and restructuring have been partly responsible for weaker-than-expected FCF in 2017, but the overall integration of Tyco appears to be on track and should support margin improvement over several years. Other rating concerns include a rapidly evolving automotive battery market served by JCI's Power Solutions and future cash deployment for acquisitions and share repurchases. Fitch believes acquisitions in the near term will be limited while JCI aligns the merged company and focuses on managing financial leverage. Sales Growth and Synergies: Sales growth has been mixed across segments and slower than anticipated, but overall segment margins have increased in the building business and remained at solid levels in the Power segment. Slow growth could partly reflect some disruption related to the integration of Tyco, which has involved the realignment of JCI's leadership structure in the Buildings business. JCI still plans to meet cost synergy and productivity savings targets in 2017 that should reach $1 billion annually by 2020. Power Solutions Provides Diversification: Power Solutions provides diversification and strong margins. It has the largest global market share among its competitors and is well positioned to generate growth through new technologies and in emerging regions. Power Solutions' strong competitive position and technical capabilities should enable it to participate in new battery technologies as they develop. Approximately three-fourths of revenue is aftermarket business, which supports margins and is relatively stable. DERIVATION SUMMARY JCI's credit profile is comparable to its global, well-capitalized peers although the realignment of its business portfolio, including the Tyco acquisition and spin-off of Adient, is contributing to near-term pressure on credit metrics including negative FCF. JCI's Building business including Tyco is comparable in scale to large competitors such as Honeywell, United Technologies, Siemens and others. Power Solutions also competes against large global peers. JCI's geographic diversification and exposure to business cycles is typical within the diversified sector. JCI's actions to boost margins and invest in new technologies should enable it to maintain competitiveness with its large peers who typically demonstrate strong technological capabilities. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Margins improve during the next several years as the merged company realizes tax savings, cost synergies between the legacy Tyco and JCI Building Experience businesses, and ongoing productivity improvements; --FCF is negative in 2017 and returns to a solidly positive level above $1 billion in 2018; --The Power Solutions business maintains its leading global market share including participating in new technologies; --Debt totals slightly more than $13 billion at the end of fiscal 2017, above Fitch's original expectation, but declines further in 2018 toward $11 billion; --The company's long-term leverage remains within steady ranges, including adjusted debt/EBITDAR in the low 3x range or below and FFO adjusted leverage in the low-to-mid-3x range. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Inability to realize expected cost synergies and margin improvement during the next few years; --FCF is inadequate to reduce debt and leverage to levels expected by Fitch; --Ineffective product development, particularly in the Power Solutions business, leads to loss of market share or lower margins; --Leverage increases for more than a short period as a result of cash deployment for acquisitions or share repurchases, including FFO adjusted leverage above 4x or gross debt/EBITDA consistently above 2.5x. Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --The integration of Tyco with JCI's Building Experience business leads to substantial gains in market share; --Higher margins and steady debt levels lead to consistently higher FCF and lower leverage, including FFO adjusted leverage below 3x; --FCF margin increases to 6%-7% compared to a stabilized level near 4% or higher as anticipated by Fitch. LIQUIDITY Liquidity at June 30, 2017 included cash of $458 million and availability under $3 billion of bank credit facilities. The facilities consist of a $2 billion facility at JCI and a $1 billion facility at TSarl that each mature in 2020. The bank facilities back commercial paper. JCI also uses supply chain financing programs to sell accounts receivable on a non-recourse basis. Scheduled maturities of long-term debt are well distributed and include slightly more than $350 million in 2018 and $500 million in 2020. Net pension liabilities totaled $1.9 billion (76% funded) as of Sept. 30, 2016. JCI plans to contribute $317 million to its pension plans in 2017, including $247 million triggered by change-in-control provisions related to the acquisition of Tyco. FULL LIST OF RATING ACTIONS Fitch has affirmed the ratings for JCI and its indirect subsidiary, Tyco International Holding S.a.r.l., as follows: Johnson Controls International plc --Long-Term Issuer Default Rating (IDR) at 'BBB+'; --Senior unsecured notes at 'BBB+'; --Senior unsecured revolving credit facility at 'BBB+'; --Short-Term IDR at 'F2'; --Commercial paper at 'F2'. Tyco International Holding S.a.r.l. --Long-Term IDR at 'BBB+'; --Senior unsecured revolving credit facility at 'BBB+'; --Senior unsecured term loan at 'BBB+'; --Short-Term IDR at 'F2'; --Commercial paper at 'F2'. The Rating Outlook is Stable. Contact: Primary Analyst Eric Ause Senior Director +1-312-606-2302 Fitch Ratings, Inc. 70 W. 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