Fitch Rates Eaton Capital Short-Term IDR 'F2'; Outlook Stable

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) for Eaton Corporation plc and its indirect subsidiary Eaton Corporation (together 'Eaton') at 'BBB+'. Fitch has also affirmed the IDR for Eaton Capital Unlimited Company (Eaton Capital) at 'BBB+' and has assigned a Short-Term IDR and Commercial Paper (CP) rating of 'F2' to Eaton Capital.

The Rating Outlook is Stable. A detailed list of ratings follows at the end of this release.

Eaton Capital's capacity to borrow CP increases Eaton's funding sources by providing it with the flexibility to issue CP outside the U.S. Commercial paper issued by Eaton Capital is guaranteed by Eaton Corporation plc.

KEY RATING DRIVERS

The ratings for Eaton consider the company's product and geographic diversification which mitigates cyclicality in its industrial end markets. Fitch's estimate of Eaton's revenue growth during the two-year period between 2015 and 2016 has weakened slightly, to a cumulative decline of 12% to 13% including the negative effect of currency movements. Sales declines are concentrated in the heavy duty truck, oil and gas, agricultural equipment and industrial markets, partly offset by growth in commercial aerospace and commercial construction. There are signs that lower demand in Eaton's hydraulics business may begin to stabilize.

Fitch estimates EBITDA in 2016 will be lower compared to 2015 due to the decline in sales. However, margins could be relatively flat due to ongoing restructuring which is targeted by the company at permanently reducing its cost structure, even when end-market demand eventually recovers. An incremental $50 million of restructuring actions are planned in 2017 in response to weak demand that would further reduce costs by $75 million on an annual basis by 2018. The company's restructuring is part of a three-year program implemented in 2015 intended to reduce the company's annual costs by more than $500 million, including recent additional restructuring.

Fitch expects that the deterioration in Eaton's end-markets will contribute to a moderate increase in debt/EBITDA to approximately 2.7x at the end of 2016, compared to Fitch's previous estimate of 2.5x and actual debt/EBITDA of 2.5x at the end of 2015. However, Fitch still expects that leverage will decline over the long term due to an improving cost structure, disciplined cash deployment, and stable debt levels near $8 billion which would fully support Eaton's 'BBB+' rating.

Rating concerns include cyclical end markets, which are currently pressuring Eaton's results, and future cash deployment for share repurchases and acquisitions that could weaken Eaton's credit metrics if funded by debt. However, Fitch expects Eaton will generate sufficient FCF to fund a $3 billion share repurchase program through 2018, including approximately $700 million in 2016. Share repurchases amounted to $567 million in the first nine months of 2016.

Fitch estimates FCF after dividends in 2016 will increase to around $1.0 billion or slightly more, compared to $839 million in 2015, and should remain at a solid level in 2017. The increase in FCF in 2016 reflects integration and restructuring benefits as well as lower pension contributions expected in 2016. Capital expenditures through Sept. 30, 2016 were 2.4% of sales on an LTM basis, which Fitch estimates could gradually return to historical levels that have been closer to 3%.

Rating concerns are mitigated by Eaton's consistently positive FCF, technological capabilities and competitive market positions. Fitch believes the company intends to maintain a strong balance sheet over the long term. Acquisitions were minimal while Eaton integrated Cooper and could eventually increase, particularly in the higher-margin electrical and aerospace businesses. Fitch would expect that in the event of a large acquisition, Eaton could reduce share repurchases to mitigate the negative impact on leverage.

Global pension plans at the end of 2015 were underfunded by $1.6 billion (73% funded). Eaton planned to contribute $162 million to these plans in 2016 compared to $330 million in 2015 and $114 million in the first nine months of 2016. The company does not anticipate making significant contributions in 2017. Eaton closed its U.S. plans to new entrants in 2013.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

--Sales decline by mid-single digits in 2016 due to weak demand and the negative impact of currency. Little improvement is anticipated in 2017;

--EBITDA margins as calculated by Fitch are nearly flat in 2016 despite lower sales as Eaton realizes benefits from operating improvements and restructuring. Margins should benefit over the longer term from a permanent reduction in the company's cost structure due to restructuring;

--FCF after dividends increases to approximately $1 billion in 2016 compared to $839 million in 2015;

--Debt stabilizes near $8 billion or slightly less after the repayment of a portion of scheduled debt maturities in 2017 using proceeds from EUR550 million of debt issued in September 2016;

--Possible increase in acquisition activity;

--Business portfolio continues to be well diversified across end markets and geographies.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--Loss of market share due to ineffective product development or higher competition;

--Less diversification that could result in more cyclical results;

--Cash deployment for share repurchases or acquisitions prevents an improvement in credit measures expected by Fitch, including a reduction of debt/EBITDA to well below 2.5x.

Future developments that may, individually or collectively, lead to a positive rating action include:

--Sustained increase in EBITDA margins from 15.9% in 2015;

--FFO adjusted leverage declines to 2.5x or below compared to 3.4x as of Dec. 31, 2015 and 3.2x at Sept. 30, 2016;

--Stronger earnings and disciplined cash deployment support a decline in leverage, including debt/EBITDA consistently below 2x;

--FCF/total adjusted debt increases to a range near the mid-teens or higher compared to 8% in 2015.

LIQUIDITY

Liquidity at Sept. 30, 2016 included $707 million of cash and short-term investments, plus availability under three revolving credit facilities totaling $2 billion. The facilities have staggered maturities between 2018 and 2021 and are used to back commercial paper. Liquidity was offset by nearly $551 million of debt due within one year, including short-term debt and current maturities of long-term debt. Debt totaled $8.5 billion at Sept. 30, 2016. The bank credit revolvers and substantially all of Eaton's and Eaton Electric Holdings' long-term debt are guaranteed by Eaton Corporation plc and certain of its U.S. and non-U.S. subsidiaries. Eaton was in compliance with all debt covenants at Sept. 30, 2016.

Eaton Corporation plc's (Eaton plc) borrower group consists primarily of U.S.-based operations of both the original Eaton Corporation (Eaton Corporation U.S.) and Cooper Industries (Eaton Electric Holdings LLC). Eaton's non-guarantor group consists primarily of companies outside the U.S. Concerns about structural subordination are mitigated by minimal debt levels at non-U.S. operating businesses. Cash flow from U.S. operations is used to service a majority of Eaton's debt while dividends are funded primarily from non-U.S. operations. Eaton generally keeps excess cash balances at international companies, and minimizes cash held in the U.S., which maximizes its flexibility to move cash among geographic locations.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following ratings:

Eaton Capital Unlimited Company

--Short-Term IDR 'F2';

--Commercial Paper 'F2'.

Fitch has affirmed the following ratings for Eaton and certain subsidiaries:

Eaton Corporation plc

--Long-Term Issuer Default Rating (IDR) at 'BBB+';

--Senior unsecured bank credit facilities at 'BBB+';

--Short-Term IDR at 'F2';

--Commercial Paper at 'F2'.

Eaton Corporation

--Long-Term IDR at 'BBB+';

--Senior unsecured bank credit facilities at 'BBB+';

--Senior unsecured debt at 'BBB+';

--Short-Term IDR at 'F2';

--Commercial Paper at 'F2'.

Eaton Electric Holdings LLC

--Long-Term IDR at 'BBB+';

--Senior unsecured debt at 'BBB+'.

Eaton Capital Unlimited Company

--Long-Term IDR at 'BBB+';

--Senior unsecured debt at 'BBB+'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.

Additional information is available on www.fitchratings.com

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014323

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014323

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Fitch Ratings

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