NEW YORK--()--Fitch Ratings has assigned an 'A-' rating to Raytheon Company's (RTN) planned issuance of senior unsecured notes in the range of up to $1 billion maturing in 2022. Proceeds will be used to redeem a total of approximately $1 billion of senior unsecured notes maturing in 2014 and 2015 and for general corporate purposes. RTN's leverage is expected to remain virtually unchanged because of the company's plans to redeem some of its outstanding notes. The Rating Outlook is Stable. A full rating list appears at the end of this release.
RTN's ratings are supported by the company's competitive position in the defense industry; good product diversification; a large portion of revenues derived from international sales; strong liquidity; and large backlog. Healthy free cash flow (FCF) generation and increasing international demand also support the ratings.
Concerns include U.S. government budget deficits and their impact on defense spending including the potential for an additional $500 billion of reductions to the Department of Defense (DoD) budget starting in January 2013; the large pension deficit and its impact on cash flows; cash deployment strategies that include increasing dividend payout and sizable share repurchases; and to a lesser extent, some pending legal issues, including one with the U.K. Home Office for the termination of the e-Borders program.
RTN's credit metrics have deteriorated over the past two years due to bond issuances that doubled the company's debt from $2.3 billion at Sept. 26, 2010 to approximately $4.7 billion in principal at Sept. 30, 2012. Of the $2.4 billion additional debt, RTN used $1.5 billion for discretionary pension contributions. Fitch views RTN's credit metrics as adequate even after the debt issuances in light of its high level of international sales, high product diversification with low exposure to any given defense program, solid liquidity and strong cash generation. Fitch notes that RTN's cushion to withstand negative developments at the 'A-' level is reduced due to increased leverage. For the last 12 months (LTM) ending Sept. 30, 2012, the company had gross leverage of 1.3x compared to 1.4x and 1.1x at the end of 2011 and 2010, respectively.
At Sept. 30, 2012, RTN had a liquidity position of $5 billion, consisting of $3.6 billion of cash and $1.4 billion of credit facility availability. In December 2011, RTN replaced its $500 million and $1 billion revolving credit facilities with a $1.4 billion revolving credit facility which will mature in 2016. Both replaced credit facilities were scheduled to mature in November 2012. The company has no debt maturities until 2014, when $575 million senior unsecured notes become due. Following the anticipated redemption of approximately $1 billion senior unsecured notes, the company's earliest maturity will be in 2018.
FCF (cash from operations less capital expenditures and dividends) for the LTM period ended Sept. 30, 2012 was approximately $1.2 billion. RTN's FCF remained relatively flat over the past two years as the company generated $1.1 billion in 2011 and $1 billion in 2010. Fitch estimates that RTN will typically generate more than $1 billion of annual FCF.
Dividends and share repurchases have been a significant use of cash in the past several years. The company spent more than $1.2 billion on share repurchases annually over the past five years and has already repurchased $725 million worth of stock during the three quarters of 2012. In March 2012, the company increased the dividend by 16% and Fitch estimates the dividend payout will reach approximately $645 million in 2012. RTN increased its dividend payout by 15% in 2011 and 21% in 2010. Fitch expects RTN to maintain its shareholder-friendly cash deployment strategies; however, share repurchases and dividend increases may moderate should the company's cash generation decline as a result of U.S. defense spending pressures.
RTN has a sizable pension deficit of $6.1 billion. RTN's pension funds are 72% funded on the basis of all plans and 74% funded for the U.S. plans. The domestic pension benefit obligation (PBO) totaled $20.3 billion at the end of 2011, while the global PBO was $21.6 billion. Required cash funding is substantial at approximately $700 million to $800 million for 2012, although the government contract reimbursements are expected to offset a significant portion of the required funding. Given the low interest rate environment, it is likely that RTN's funding position could further deteriorate by the end of this year.
U.S. government spending trends are key drivers of RTN's financial performance given that the company generates most of its revenues from the U.S. government (approximately 74% in 2011, excluding foreign sales through the U.S. government), primarily from the defense industry. High levels of defense spending currently support RTN's ratings, but the DoD budget environment is highly uncertain because of large U.S. government budget deficits and the potential for large, automatic spending cuts beginning in fiscal 2013.
U.S. defense spending has been on an upward trend for more than a decade, but the fiscal 2012 and fiscal 2013 budgets represent a turning point, with spending beginning to turn down in fiscal 2013, even excluding war spending, albeit from very high levels. The fiscal 2012 DoD base budget is up less than 1% compared to fiscal 2011, and the requested base budget for fiscal 2013 is down 1% to $525 billion.
Fiscal 2013 modernization spending (procurement plus research and development [R&D]), the most relevant part of the budget for defense contractors, is down 4%, the third consecutive annual decline by Fitch's calculations. The overhang of potential automatic cuts beginning in early 2013 related to the 'sequestration' situation add to the uncertainty faced by defense contractors in the current environment. The U.S. defense outlook will be uncertain and volatile over the next one to two years, and program details will be needed to evaluate the full effect on RTN's credit profile.
Fitch would not expect modest declines in defense spending to lead to a negative rating action because RTN's exposure to DoD spending is mitigated by good liquidity, diversification of its product line, and high percentage of sales to foreign customers, all of which make up fixed price contracts. RTN's sales are not tied to any major program and its largest program is the Patriot Missile Long-Range Air-Defense System, one of the most funded and sought after systems worldwide. RTN does not have a single contract which represents more than 5% of the company's revenues.
What Could Trigger A Rating Action
Despite increased leverage and concerns regarding the U.S. budgetary environment, RTN's liquidity position and strong cash generation afford the company some cushion to withstand negative developments at the current ratings. Fitch may consider a negative rating action should there be a dramatic change in U.S. defense spending policies, poor execution on a number of key contracts, and/or a major change in the company's financial strategy. A positive rating action is unlikely in the near term given increased leverage, the company's cash deployment strategies, and the current uncertainty surrounding U.S. federal budgets.
Fitch currently rates RTN as follows:
--Issuer Default Rating (IDR) 'A-';
--Senior unsecured debt 'A-';
--Bank facilities 'A-';
--Short-term IDR at 'F2';
--Commercial paper programs 'F2'.
The Rating Outlook is Stable
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 8, 2012
--'Rating Aerospace and Defense Companies: Sector Credit Factors' August 9, 2012