S&P Cuts Philips N.V. (PHG) to 'BBB+'; Notes Weak Operational Performance

Standard & Poor's Ratings Services today lowered its long-term corporate credit and debt issue credit ratings on The Netherlands-based diversified technology group Koninklijke Philips N.V. (NYSE: PHG) to 'BBB+' from 'A-'. The outlook is stable.

We affirmed our 'A-2' short-term rating on the group.

The downgrade reflects Philips' weak operational and financial performance in 2014 due to a moderate decline in its underlying performance and significant incidental charges that further depressed reported earnings. This has led us to reassess Philips' financial risk profile assessment as "intermediate" from "modest." Philips' funds from operations (FFO) to debt in 2014 was only 27% (about 35% when adding back the earnings contribution from the Lumileds and automotive business, which had been reported under discontinued operations). This is well below the level we consider commensurate with the previous 'A-' rating (above 50%). We don't expect Philips will be able to improve this metric in the near team. This is because ongoing remediation in its Healthcare Equipment business related to the suspension of its Cleveland facility, as well as continued restructuring of its operations including the costs related to the separation of its lighting business, will likely weigh on 2015 earnings.

In late 2014, Philips announced its intention to separate its lighting business, which generates about 32% of the group's revenues. The group is currently carving out the business, a process that is expected to be completed by the first half of 2016. Philips is reviewing strategic options, including an IPO and/or an outright sale to a strategic or financial investor. We see potential for substantial proceeds that could benefit Philips' financial risk profile in the future. However, we consider the implications of the exit to be relatively uncertain at this stage. We also don't yet know what the capital structure of the remaining company will be, or how Philips' existing debt and contingent liabilities will be assumed or allocated. We therefore continue to focus our analysis on the current group structure.

The stable outlook reflects our expectation that the ratings on Philips will remain unchanged following the execution of the split-off of the Lighting business. This rests on the assumption that Philips' credit metrics will recover to levels solidly commensurate with an "intermediate" financial risk profile, including FFO to debt of more than 40%.

We would raise the rating if Philips generated substantial proceeds from the exit of Lighting, leading to metrics sustainably above 55%. This would entail a clear view on the group's financial policy, including management's view on the pace of inorganic growth in its remaining HealthTech operations, and future shareholder remuneration policies. It would likely also entail a sustainable upturn in performance by Philips' remaining operations, supported by a positive earnings trend throughout the remainder of 2015 and in 2016.

We could lower our ratings on Philips if we anticipated that its adjusted debt to EBITDA was likely to exceed 2.5x or FFO to debt stayed below 40% on a sustainable basis. This could occur if the group was unable to generate any proceeds from the exit from Lighting and if the company experienced continued stress on its operating performance. We see this case as relatively unlikely given the generally favorable outlook for the group's Healthcare and Consumer Lifestyle operations.

You May Also Be Interested In

• U.S. Bancorp (USB) PT Lowered to $54 at Oppenheimer
• Carvana (CVNA) PT Raised to $70 at JPMorgan, Adds CarMax (KMX) To Negative Catalyst Watch
• MYT Netherlands Parent B.V. (MYTE) Announces Preliminary Third Quarter Results – Double-Digit Topline Growth Significantly Improved Profitability