Moody's Downgrades United Technologies' (UTX) Senior Unsecured Rating to 'A3'; Outlook Stable

Moody's Investors Service downgraded its ratings for United Technologies (NYSE: UTX), lowering the senior unsecured debt rating to A3 from A2, the junior subordinated notes rating to Baa1 from A3, and the short-term commercial paper rating to P-2 from P-1. The rating outlook is stable.

RATINGS RATIONALE

"The downgrades reflect Moody's expectations for a heightened risk profile at UTC -- in financial policy, potential investment appetite and business operations -- a condition which has been developing gradually," according to Russell Solomon, Senior Vice President and Moody's lead analyst for the company. "In particular, Moody's believes there is likely to be a more aggressive financial risk tolerance than has been characteristic of UTC in the past. This developing shift is coincident with senior management changes over the past year, and comes at a time when the fundamental business operations lag prior expectations," added Solomon. "Our base case, reflective of the A3 senior debt rating, now incorporates the expectation that higher debt and financial leverage is more likely than previously anticipated for some combination of shareholder returns, business investment or acquisitions. The long term rating could be pressured further with an outsized debt-funded acquisition."

Ratings for United Technologies continue to broadly reflect the company's large size and geographic scale (with revenue likely to be around $65 billion this year, or about $58 billion excluding the Sikorsky helicopter business pending its sale later this year or early next year), leading positions in growing business lines including aerospace and building services, strong operating margins that are expected to consistently be in the mid-teens percentage range, and stable free cash flow generation that is forecast to exceed $3 billion (after dividends) next year. An intense focus on cost management that remains integral to normal course operations has contributed to high and relatively consistent operating performance for some time, notwithstanding some slow-down and lagging performance metrics of late. UTC benefits from a sizeable installed equipment base and order book, and the expected long-term growth prospects associated with high-margin, annuity-like revenue streams inherent to most of its aerospace and industrial business lines.

Liquidity is excellent overall, albeit with increasing challenges related to tax ramifications with most cash balances trapped overseas, and ensuing excessive short-term commercial paper borrowings that increasingly look to be a permanent part of the capital structure (whether they are termed out or not). Ongoing heavy requisite capital investment in support of new product launches and a steep production ramp will continue to constrain forward cash flows. Mix changes, foreign currency exchange and oil price volatility, tight defense budgets, stagnant macroeconomic conditions in Europe and a slow-down of growth in China and other emerging markets are expected to persist, prompting an even more heightened competitive environment which will also pressure forward earnings. Financial leverage remains elevated at more than 2.5x on a Moody's-adjusted Debt-to-EBITDA basis, with expectations of further balance sheet strain (2.7x-to-2.8x range) over the forward rating horizon as debt issuance continues to support incremental share repurchase activity and inorganic growth through acquisition under financial policies that seem more closely aligned to a "Baa" than an "A" credit profile.

RATINGS OUTLOOK

The stable outlook anticipates a leverage profile that will remain elevated for the rating category over the forward rating horizon (2.5x-to-3.0x on a Moody's-adjusted Debt-to-EBITDA basis), with earnings growth tempered in the near-term but ongoing support of the company's share price persisting, nonetheless. Overseas cash is expected to grow and partially offset incremental debt issuance but will likely be earmarked for future acquisitions, which should be moderately sized (sub-$5 billion) to support the stable outlook while leverage remains elevated.

WHAT COULD CHANGE THE RATING - UP

With this action, Moody's does not anticipate a rating upgrade for the near term. The macroeconomic environment would have to materially improve, along with expanding margins and free cash flow generation. A return of Moody's-adjusted Debt-to-EBITDA to the low-2x range, with expectations that it would remain as such or lower and if accompanied by sustainment of an excellent liquidity profile, could potentially support a return to a mid-single-A rating.

WHAT COULD CHANGE THE RATING - DOWN

Should events occur that impair the company's ability to maintain a strong credit profile, such as more sizeable debt-financed acquisitions and/or even more aggressive shareholder return initiatives than currently anticipated, then ratings could again be downgraded. If Moody's-adjusted Debt-to-EBITDA is expected to exceed 3x on a sustained basis, consideration of a Baa rating could be warranted, particularly if the business environment does not improve and/or the company fails to successfully execute over the coming transition period in most respects.

The principal methodology used in these ratings was Global Aerospace and Defense Industry, published in April 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

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