Fitch Cuts Long-Term Ratings on HP, Inc. (HPQ) to 'BBB+', Removes from Watch Negative (HPE)

Fitch Ratings has downgraded the long-term ratings of Hewlett-Packard Company (Hewlett-Packard) to 'BBB+' from 'A-', removed the ratings from Rating Watch Negative and assigned a Stable Outlook . The short-term ratings are affirmed at 'F2'. At the same time, Fitch notes the change in the company's name to HP, Inc. (NYSE: HPQ) (HPI) from Hewlett-Packard following the completion of the company's separation from Hewlett-Packard Enterprises Inc. (HPE) on Nov. 1, 2015. Fitch's ratings affect $6.8 billion of debt. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

Fitch's ratings reflect expectations for solid operating results despite secular demand challenges in HPI's core markets. The business separation will support operating profit margin expansion and solid annual free cash flow (FCF; Fitch defined as after dividends). A commitment to conservative financial policies through the rating horizon and investments in adjacent growth markets in the long term should offset Fitch's expectations for sustained top-line pressures in core markets.

Fitch expects HPI's core printing and PC market will remain challenged for the foreseeable future, likely declining in the low- to mid-single digits annually. Reduced demand for printing, particularly among consumers, should continue pressuring printer sales and highly profitable ink replacement cartridges, which Fitch believes contribute significant recurring revenue.

To offset core printing market declines, HPI will focus on markets expected to deliver at least double-digit growth over the foreseeable future (including A3, graphics, and 3D printing), albeit from very small revenue bases. Fitch believes meaningful growth from investments in these markets likely will occur beyond its forecast period (through fiscal 2017).

Fitch expects PC unit sales to continue declining in the mid- to high-single digits as consumers extend replacement cycles and increasingly prefer larger-screen smartphones to PCs for non-productivity-based uses. Fitch does not anticipate significant uplift from Windows 10, but ongoing consolidation of the PC market by the top 3 vendors (HP, Lenovo and Dell) and increased thin client and mobility sales could offset core market declines.

Profitability should expand from restructuring and efficiency initiatives, despite negative revenue growth and increased investments in growth markets. Fitch believes cost take-outs will drive operating EBIT margin to mid-single digits from low-single digits pro forma for the separation. As a result Fitch expects more than $1 billion of annual FCF through the rating horizon.

Fitch expects HPI's financial policies will remain conservative through at least the intermediate term as the company focuses on resuming positive revenue growth. Fitch expects total leverage (total debt-to-operating EBITDA) to remain below 1.5x and solid liquidity and annual FCF, although the company may use FCF for a combination of acquisitions and shareholder returns..

The ratings and Outlook also reflect Fitch's expectations for:

--Strong liquidity and conservative financial policies supported by solid cash and investments, an undrawn revolving credit facility (RCF) that will fully backstop a CP program, solid annual FCF and total leverage below 1.5x;
--Strong share positions in each of its core markets, including laser and ink printing and the $170 billion core PC market, all of which are facing secular headwinds but provide substantial scale to support investments in growth markets;
--Significant geographic, market, customer and product diversification, which should reduce operating volatility, despite exposure to cyclical demand patterns;
--Large printer and PC installed base, providing substantial and highly profitable recurring revenues and platform for increasing supplies and services penetration.

The ratings also consider Fitch's expectations for:

--Long-term secular declines in printers and PCs, which will likely decline in the low- to mid-single digits through at least the intermediate term and require HPI to urgently gain traction in growth markets;
--Growth markets to develop beyond the intermediate term, potentially testing shareholders' patience for more aggressive financial policies;
--Aggressive pricing pressures, particularly in PCs, where Fitch anticipates second- and third-tier players will aggressively seek to regain declining market share;
--Acquisition activity to gain intellectual property (IP) in growth markets that are likely to be expensive for the attendant incremental cash flows.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for HPI include:
--Core printing and PC markets declining in the low- to mid-single digits through the intermediate term, resulting in slightly negative revenue growth through the forecast period (fiscal 2015 through fiscal 2017);
--Growth initiatives begin gaining traction in fiscal 2016 but have only modest impact through the forecast period;
--Cost reductions and efficiency initiatives support consistent-to-slightly stronger operating profit margins, despite top-line headwinds and increased investments in growth markets;
--HPI will use FCF for a combination of acquisitions and shareholder returns;
--Total debt for HPI of $6.8 billion.

RATING SENSITIVITIES

The ratings could be downgraded if Fitch expects:

--Organic constant currency revenue growth will remain negative beyond the intermediate term, driven by investments in growth markets failing to offset secular declines in core markets;
--Profitability will remain closer to mid-single digits, indicating more significant than anticipated top-line pressures or insufficient restructuring, resulting in lower annual FCF and pushing total leverage closer to 2x.

Positive rating actions are not anticipated in the intermediate term but could occur if Fitch expects:

--Sustained positive revenue growth, driven by significant penetration in growth markets, offsetting secular declines in core printing and PC markets;
--HPI will achieve high-single-digit operating profit margin, driving significantly higher annual FCF and enabling the company to maintain total leverage below 1.5x.

LIQUIDITY

Fitch believes HPI's liquidity is strong and supported by:

--$4.5 billion of cash and investments, the vast majority of which is located overseas but is available in the short term via inter-company loans;
--A $4 billion RCF expiring in 2019 that could fully backstop a commercial paper (CP) program.

In addition, more than $1 billion of annual FCF also will support liquidity.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings for Hewlett-Packard Company and assigned Outlooks as indicated:

--Long-Term Issuer Default Rating (IDR) to 'BBB+' from 'A-'; assigned a Stable Outlook
--RCF to 'BBB+' from 'A-';
--Senior Unsecured Debt to 'BBB+' from 'A-'.

In addition, Fitch has affirmed the short-term IDR and CP at 'F2'.

Fitch has withdrawn the expected ratings for the HP Inc. record, which served as a placeholder entity until the separation was effected.

You May Also Be Interested In

• HP Inc. (HPQ) Amends Bylaws to Decrease Board to 12 Seats
• Moody's Raises Meta Platforms' (META) Senior Unsecured Notes Rating to Aa3 From A1
• HP Unveils Canadian Cohort for 2024 Digital Equity Accelerator Program