S&P Lowers Outlook on Eaton (ETN) to Negative; Sees Weaker End-Market Demand

Standard & Poor's Ratings Services said that it has revised its outlook on Eaton Corp. (NYSE: ETN) to negative from stable.

At the same time, we affirmed all of our ratings on the company, including our 'A-' corporate credit rating.

"The outlook revision reflects the weaker demand in Eaton's end markets and the potential that its credit measures could deteriorate over the next two years such that they no longer support our current ratings on the company, including an adjusted funds from operations (FFO)-to-debt ratio that is comfortably above 30% by 2017," said Standard & Poor's credit analyst James Siahaan.

The negative outlook on Eaton reflects our view that the company's operating performance may continue to weaken, which could either cause it to fail to generate an adjusted FFO-to-total adjusted debt ratio that is comfortably above 30% or render it unable to maintain an adjusted debt-to-EBITDA ratio of less than 3x by the end of 2017. Eaton's end markets are experiencing weaker demand, particularly in its hydraulics, vehicle, and electrical systems and services segments. While the company has paid down some of the debt it incurred for its 2012 acquisition of Cooper Industries, its almost $10 billion of adjusted debt still represents almost 3x its EBITDA, which is relatively high compared with its peers. While we do not expect Eaton to make any sizable debt-funded acquisitions (and the savings from its three-year restructuring plan may help its operating results somewhat), a weak macro environment and an increased level of share repurchases will likely cause the company's credit measures to remain weak for the current ratings.

We could revise our outlook on Eaton to stable if the company repays more debt than we had anticipated, or if market conditions and its operating performance improve such that it appears likely that it will achieve a FFO-to-debt ratio comfortably within the 30%-45% range. It is unlikely that we would raise our ratings on Eaton over the next year because we do not expect the company's FFO-to-debt ratio to exceed the aforementioned range that we expect for the current ratings.

We could downgrade Eaton if the weak market conditions in its industrial sector continue, or if less conservative financial policies--including large dividend increases and share repurchases--delay the expected improvement of its credit measures. The company's FFO-to-total adjusted debt ratio has fallen below 30% in recent periods. Without a clear path toward improvement by the end of 2017, this could also lead us to consider downgrading the company.

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