CHICAGO--Fitch Ratings has affirmed the ratings for Rockwell Automation, Inc. (Rockwell), including the company's long-term Issuer Default Rating (IDR) at 'A' and short-term IDR and commercial paper (CP) ratings at 'F1'. The Rating Outlook is Stable.
Fitch's actions affect $1.65 billion of total debt outstanding as of Dec. 31, 2015. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings and Stable Outlook reflect Fitch's expectations for near-term softness in Rockwell's operating results in the context of healthy longer-term growth in demand for industrial automation solutions. The company's diversified end market exposure reduces operating volatility, although demand within most of Rockwell's markets moves in tandem with regional gross domestic product and industrial production. Higher software and services content will increase the mix of revenues and cash flows that are recurring in nature, potentially further reducing operating volatility over time.
Rockwell's recent results have been pressured by slower organic growth and foreign currency weakness. Sales growth turned negative in fiscal 2015 (ended Sept. 30) and in the first quarter of fiscal 2016, and Fitch expects a low single digit organic sales decline in fiscal 2016, which together with currency weakness will lead to a total sales decline of around 7%. This reflects weakness in heavy industries, including oil and gas and mining, offsetting modest growth in auto and consumer end markets. Geographically, weakness in the U.S. and key emerging markets, such as China and Brazil, is expected to offset growth in Europe and Mexico.
Despite sales weakness, operating margins have held up reasonably well due to the company's productivity initiatives. Fitch expects the EBITDA margin will narrow slightly in fiscal 2016 and 2017 due to lower volumes, but that it will remain at or above 20%, in-line with the 22% level for the latest 12 months (LTM) ended Dec. 31, 2015.
FCF is expected to decline to around $400 million in fiscal 2016 from $715 million in fiscal 2015 due to lower EBITDA and higher capex and dividends. FCF will likely track at around this level over the next two to three years as earnings remain below fiscal 2015 levels and dividends continue to grow. Approximately half of pre-dividend FCF is generated outside the U.S., forcing the company to borrow domestically to support dividends and share repurchases even as significant overseas cash balances continue to grow. Fitch also expects smaller bolt-on acquisitions, although the company is focused primarily on organic growth.
Fitch anticipates Rockwell's credit metrics will weaken over the near term as EBITDA declines to the $1.2-1.3 billion range in fiscal 2016 from $1.4 billion in fiscal 2015, while debt levels grow to finance shareholder returns and acquisitions. Fitch expects debt/EBITDA could increase to around 1.6x in fiscal 2016 from 1.1x at the end of fiscal 2015, and move modestly higher in fiscal 2017. This leverage is within the tolerance for the 'A' rating, though it leaves less cushion for operating shortfalls or larger acquisitions.
Fitch gives primary weight to gross leverage ratios but also considers Rockwell's significant cash and short-term investments of $2.2 billion, of which, approximately 90% of which is held in foreign accounts, and would be subject to taxation if repatriated to the U.S.
There are no required contributions to Rockwell's domestic pension plans over the intermediate term; the company has ample foreign liquidity to support modest contributions to worldwide plans.
The ratings and Outlook are supported by:
--Strong competitive position supported by technological differentiation and domain expertise;
--Leading share within secular growth automation markets;
--Solid end-market and customer diversification, which helps to lower operating volatility through the cycle.
Ratings concerns include:
--Weaker operating performance over the near to medium term, modestly constraining FCF;
--Domestic cash flow that is not sufficient to support; Rockwell's shareholder returns strategy, resulting in higher debt balances over time.
Fitch's key assumptions within our rating case for the issuer include:
--Sales decline by 7% in fiscal 2016 (4% currency-related), are flat in fiscal 2017 and then grow at 3% annually thereafter.
--The EBITDA margin narrows slightly in fiscal 2016 and 2017 due to lower volumes, and recovers beginning in fiscal 2018.
--Debt levels grow moderately over the forecast horizon to cover domestic cash flow shortfall relative to dividends, share repurchases and acquisitions.
--FCF of around $400 million annually, or 6-7% of revenues.
--Debt/EBITDA moves up from a projected 1.6x at the end of fiscal 2016 to 1.8x over the forecast horizon.
Future developments that may, individually or collectively, lead to a negative rating action include:
--A sustained increase in debt/EBITDA above 1.75x or FFO adjusted leverage above 2.5x beyond short-term cyclical or acquisition-driven upticks;
--FCF margin below 5%, driven by cyclical or competitive pressures, if not mitigated by reduced share repurchases.
Positive rating actions are unlikely in the absence of structurally higher FCF and domestic liquidity.
Rockwell has strong liquidity as of Dec. 31, 2015, supported by cash and short-term investments of $2.2 billion and a $1 billion revolver expiring March 2020. The revolver supports CP issuance, of which there was $161 million at Dec. 31, 2015. Approximately 90% of the company's total cash and short-term investments of $2.2 billion is held in foreign accounts.
FULL LIST OF RATING ACTIONS
Fitch affirms Rockwell's ratings as follows:
--Long-term IDR at 'A';
--Short-term IDR at 'F1';
--Senior unsecured bank facilities at 'A';
--Senior unsecured long-term debt at 'A';
--CP at 'F1'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: March 29, 2015
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form