Fitch Affirms Ratings of TE Connectivity (TEL) Following Recent Q1 Results

Fitch Ratings affirms the ratings for TE Connectivity Ltd. (NYSE: TEL) and its wholly owned subsidiary, Tyco Electronics Group S.A. (TEGSA). The Rating Outlook is Stable. Fitch also assigns an 'A-' rating to the company's new $350 million 10-year unsecured notes.

The ratings affect $3.7 billion of total funded debt, excluding the $500 million floating rate notes due Jan. 29, 2016, which Fitch expects will be repaid at maturity on Friday. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The ratings and Outlook are supported by TE Connectivity's leading market positions across several connector categories, broad portfolio of connectors, sensors and integrated offerings, global presence, embedded customer base, and Fitch's expectations for robust free cash flow and low total leverage (total debt to operating EBITDA). TE Connectivity's diverse and resilient business model and likely continued conservative financial policies provide the company with flexibility to absorb unexpected operational or financial stresses - a key characteristic of the 'A' rating category for cyclical companies.

Fitch expects mid-cycle net sales growth in the mid-single digits, driven by secular demand drivers for harsh environment electronic content and sensors. The prospect of integrated product offerings containing both connectors and sensors increases confidence that TE Connectivity can sustain this level of growth, in Fitch's view.

In fiscal 2015, revenue grew organically by 3.8% despite weakness in China, supply chain inventory corrections, product exits in Data & Devices and derivative effects of weak oil & gas markets. Total revenue grew 2.2%, negatively impacted by $955 million of currency headwinds. The company is guiding to 4% organic revenue growth in fiscal 2016 based on expectations for strong performance in Automotive, Sensors, Aerospace & Defense, SubCom and Appliances, partially offset by weakness in Oil & Gas and product exits in Data & Devices.

TE Connectivity maintains a high exposure to the automotive market, which accounted for 39% of fiscal 2015 revenue. Fitch believes increasing electronic content driven by new emissions standards, increased safety requirements and hybrid and electric cars positions TE Connectivity to outperform automotive vehicle production growth over the medium to long-term, despite the potential for cyclical downturns temporarily impacting revenue and margins. Also, significant operational restructuring undertaken since the last downturn should help improve bottom-cycle profitability compared with the last recession.

Fitch expects mid-cycle operating margins to continue to trend toward the upper teens based on continued restructuring initiatives and operating leverage. Operating margins in fiscal 2015 increased 80 bps to 16.3%, due mainly to efficiency programs and an increasing mix of harsh environment revenue, which increased from 70% to 80% following the sale of Broadband Network Solutions (BNS) and a few harsh environment acquisitions in fiscal 2015.

A comparatively large R&D budget combined with embedded relationships with global OEM leaders across a variety of industries enables TE Connectivity to remain ahead of the technology curve. As the largest connector company in North America and Europe, and one of the largest in China, TE Connectivity has significantly more capital for research, development and engineering compared with the thousands of local and regional connector companies that comprise about 40% of industry revenue. Further, technology innovations by competitors may only be relevant for a select number of products, or a single generation of products, resulting in only a temporary and potentially immaterial loss of business.

Fitch expects annual FCF approaching $1 billion over the rating horizon, within the context of mid-single digit revenue growth. Fitch believes TE Connectivity's countercyclical working capital needs also support cash generation of about $1 billion during a downturn supported by inventory and accounts receivable liquidation; in 2009, inventory and accounts receivable reductions contributed about $1.3 billion to cash from operations. Cash pension obligations are minimal over the next few years, and the company expects to settle its obligations related to its tax sharing agreement with Tyco International and Covidien for about $147 - 163 million in fiscal 2016.

Fitch expects TE Connectivity's financial policies will remain largely unchanged. The company targets returning two thirds of free cash flow to shareholders in the form of dividends and share buybacks. The company has publicly stated that it will complete its $3 billion of share buybacks from the BNS sale proceeds in fiscal 2016. Fitch anticipates the company will manage debt in accordance to its total leverage target of below 2.0x. As of Dec. 25, 2015, total leverage was 1.5x, pro forma for the $350 million 10 year unsecured notes and repayment of the $500 million floating rate notes due Jan. 29, 2016.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Low to mid-single digit organic revenue growth in fiscal 2016, mid-single digits thereafter;
--Operating margin approaches 18% based on operating leverage and efficiency programs;
--One third of FCF spent on acquisitions;
--Aggregate dividend growth of 10% per year beginning fiscal 2017;
--Total share repurchases of $2.7 billion in fiscal 2016 (representing the remainder of the BNS sale proceeds following fiscal Q4 buybacks); beginning in 2017, remaining free cash flow after M&A and dividends used for repurchases;
--Capex of 5% of total revenue, in line with historical levels;
--One time cash outflow of $155 million in 2016 (mid-point of expected range) for settlement related to tax sharing agreement.

RATING SENSITIVITIES

Fitch believes further positive rating action is unlikely in the absence of a commitment to more conservative financial policies, including leverage closer to 1.0x, which Fitch does not expect serves TE Connectivity's flexibility. Fitch believes the company will want to maintain the financial flexibility to pursue consolidation opportunities in the fragmented sensor and industrial markets.

Conversely, negative rating actions could occur if Fitch expects:
--Operating profit margins will remain below the 10%-15% range beyond the short term, driven by TE Connectivity's inability to offset pricing pressures or commodity price volatility with new product introductions and productivity gains;
--Total leverage sustaining above 2.0x, potentially due to more aggressive shareholder returns or leveraged acquisitions; or
--Fitch's expectations for annual FCF sustaining below $750 million beyond the short term.

LIQUIDITY

Liquidity as of Dec. 25, 2015 was solid with a cash balance of $2.2 billion and an undrawn $1.5 billion senior unsecured revolving credit facility, which fully supports the company's $1.25 billion commercial paper (CP) program. Fitch's expectation for annual FCF approaching $1 billion also supports liquidity.

The ratings and Outlook accommodate cash for pension contributions and assume a one-time cash settlement payment of $155 million in 2016 related to the company's obligations under its tax sharing agreement with Tyco International and Covidien.

Total unadjusted funded debt as of Dec. 25, 2015, pro forma for the $350 million unsecured notes and repayment of the $500 million floating rate notes due Jan. 29, 2016, was approximately $3.7 billion and primarily consisted of:

--$1,250 million CP program ($0 outstanding);
--$1,500 million unsecured senior revolving credit facility due Dec. 9, 2020 (undrawn);
--$708 million of 6.55% senior unsecured notes due Oct. 1, 2017;
--$325 million of 2.375% senior unsecured notes due Dec. 17, 2018;
--$250 million of 2.35% senior unsecured notes due Aug. 1, 2019;
--$250 million of 4.875% senior unsecured notes due Jan. 15, 2021;
--$500 million of 3.5% senior unsecured notes due Feb. 3, 2022;
--$600 million (EUR550 million) of 1.1% senior unsecured notes due March 1, 2023;
--$250 million of 3.45% senior unsecured notes due Aug. 1, 2024;
--$477 million of 7.125% senior unsecured notes due Oct. 1, 2037;
--New $350 million 10-year unsecured notes.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the ratings for TE Connectivity and TEGSA as follows:

TE Connectivity:
--Long-term Issuer Default Rating (IDR) at 'A-';
--Short-term IDR at 'F2'.

Tyco Electronics Group S.A.
--Long-term IDR at 'A-'
--Short-term IDR at 'F2';
--CP program at 'F2';
--Senior unsecured credit facility at 'A-';
--Senior unsecured notes at 'A-'.

Fitch has also assigned an 'A-' rating to the company's $350 million 10-year unsecured notes.

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