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Moody's Raises Eaton Corp plc (ETN) Outlook from Negative to Stable

April 7, 2014 3:29 PM EDT

Moody's Investors Service affirmed the Baa1 senior unsecured and Prime-2 ratings of Eaton Corporation (NYSE: ETC) as well as the (P)Baa1 rating for its senior unsecured shelf registration. At the same time, the Baa1 rating of Cooper US, Inc. (Cooper) was also affirmed. The rated long-term debt of both Eaton and Cooper are supported by the identical set of guarantees from their ultimate parent (Eaton Corporation plc) and by various subsidiaries. The rating outlook was revised to stable from negative.

RATINGS RATIONALE

Eaton's Baa1 rating reflects its significant scale, product and geographic diversification, substantial capital base, and track record of profitability and free cash flow generation. It also considers elevated leverage and lower coverage metrics that arose from debt incurred to fund the $13 billion acquisition of Cooper Industries in late 2012. Credit metrics have improved but further progress would strengthen the company's positioning in the current rating category.

Eaton is publicly committed to restoring stronger ratings. In 2013 the company lowered its balance sheet debt by some $1.3 billion and the funded position of its pension plans improved by roughly $.5 billion. A key challenge for further progress is the pace at which it can harvest operational and financial benefits of the Cooper acquisition in a modest growth environment (3% organic growth is anticipated in most of its end-markets in 2014). Strategically, the transaction will reduce the amplitude of the company's cyclicality by improving the balance between its short, intermediate and long cycle businesses and by better positioning itself to participate in higher growth sectors over time.

The stable outlook recognizes that, although the company's leverage remains high for the rating, progress has been made in paying-down debt with further reductions anticipated over the next 12-18 months, making it less likely that lower ratings would develop. The stable outlook is supported by the company's commitment to further de-leveraging and prospects for modest growth and good liquidity. Should significant capital be deployed in acquisitions or share repurchases rather than debt reduction, the outlook or ratings could be revisited.

A positive outlook or stronger ratings could develop if Eaton is successful at harvesting opportunities associated with Cooper and demonstrates a commitment to maintaining a stronger financial profile. Metrics that could signal positive rating action include: EBITA/interest exceeding 7x; debt/EBITDA below 2.5x; and free cash flow/debt approaching 12%. Over the period through December 2015, approximately $1.3 billion of long-term debt matures. If retired, pro forma debt/EBITDA using trailing 2013 EBITDA would be approximately 3 times, inferring that both debt reduction and earnings growth would be necessary for a positive outlook or stronger ratings.

The outlook would come under pressure if Eaton's credit metrics weakened appreciably due to difficulties in integrating Cooper or capitalizing on anticipated synergies. In addition, a severe downturn in major markets that was not offset by strength in other areas or a sizable acquisition or shareholder distribution undertaken during the intermediate term could adversely impact the rating. Metric levels suggestive of rating pressure include EBITA/interest below 4x, debt/EBITDA above 3.5x, and free cash flow/debt below 8%.

The principal methodology used in rating Eaton Corporation was the Global Heavy Manufacturing Rating Methodology published in November 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

The last rating action was on November 2012 at which time senior unsecured ratings of Baa1 were assigned to issues of Turlock Corporation, which have since been legally assumed by Eaton Corporation, and a negative rating outlook was established.



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