News Column

Fitch Affirms Eaton's IDR at 'BBB+'; Rating Outlook Stable

June 19, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Issuer Default Ratings (IDR) for Eaton Corporation plc and its indirect subsidiary Eaton Corporation (together 'Eaton') at 'BBB+'. The Rating Outlook is Stable. A detailed list of ratings follows at the end of this release.

KEY RATING DRIVERS

Eaton's operating and credit profiles continue to improve as it integrates Cooper and pays down debt used to fund the acquisition. Fitch expects Eaton will realize higher margins associated with cost and revenue synergies, and stronger free cash flow (FCF), as Eaton completes the integration by late 2015. The combination of stronger operating results and lower debt could eventually lead to a positive rating action. However, Fitch estimates credit metrics could remain weak for the rating for up to two years, although faster improvement is possible. A positive rating action would depend on Eaton achieving expected margin and FCF results, and increased visibility concerning unresolved litigation matters.

Rating strengths include Eaton's technological capabilities, competitive market positions, and geographic and product diversification that mitigate sensitivity to cyclical end-markets including heavy duty trucks, automotive, construction and aerospace. Liquidity is solid and pension funding continues to improve.

Eaton reduced total debt by $1.3 billion in 2013 and plans to repay an additional $1.8 billion of debt through early 2016. Debt/EBITDA declined to 2.9x as of March 31, 2014 from approximately 5x at the end of 2012. Fitch estimates leverage will decline toward 2.5x in 2014 and below 2.0x by the end of 2015. FFO adjusted leverage could also improve to around 2.5x by the end of 2015 from 3.8x at the end of 2013.

Synergies associated with integrating Cooper include $100 million of annual cost improvements in 2013 and an additional $225 million by the end of 2016. Synergies reflect the combined companies' larger scale, in-sourcing opportunities, and the elimination of redundant corporate expenses. Segment margins increased slightly more than 100 bps in 2013. Fitch estimates EBITDA margins will improve by as much as 300 bps over the next two years due to the expected synergies, lower integration costs beginning in 2015, and modest restructuring at Eaton's industrial businesses.

Rating concerns include antitrust litigation, integration risk, and discretionary spending for share repurchases and acquisitions which can be expected to resume after the Cooper integration is complete. However, Fitch believes Eaton will generate sufficient FCF to fund a moderate level of expenditures, and that the company intends to maintain a strong balance sheet over the long term. Integration risks related to Cooper have diminished as Eaton achieves planned synergies, but materially higher margins in the next two years will require effective completion of the integration.

Litigation risk centers on claims by Meritor of as much as $800 million that originated in 2006. If Meritor prevails, the amount of any award would be tripled under antitrust laws. A trial is scheduled for late June 2014. An adverse decision would have a negative impact on Eaton's liquidity and could delay the anticipated improvement in credit metrics. However, Eaton generates sufficient FCF to rebuild its balance sheet and credit measures in a short-to-medium timeframe if such an event occurs. Separately, Eaton recently agreed to pay $147 million as part of a settlement to resolve long-running litigation with Triumph Group involving trade secret matters.

FCF in 2013 of $875 million was slightly lower than the level of at least $1 billion expected by Fitch. The difference largely reflected cash requirements for working capital and taxes, but Fitch believes Eaton's fundamental operating performance remains on track. Fitch estimates FCF in 2014 will increase to approximately $1.2 billion in 2014 as improving financial results are partly offset by integration costs. These costs should decline materially in 2015.

FCF includes capital expenditures that Eaton expects will remain stable near 3% of sales, and dividends are likely to increase in line with earnings. Other cash deployment includes share repurchases, but there were no repurchases in 2012 or 2013. Repurchases could increase as Eaton nears the end of its planned debt repayment and generates excess cash.

Pension contributions to global plans totaled $341 million in 2013 which Eaton estimates will increase slightly to $362 million in 2014. Eaton contributed $238 million in the first quarter of 2014. As of Dec. 31, 2013, global plans were underfunded by nearly $1.4 billion (76% funded) including U.S. plans that were 81% funded. The underfunded amount improved substantially from nearly $2 billion one year earlier as a result of contributions, strong asset returns and a higher discount rate.

Liquidity at March 31, 2014 included $1.1 million of cash and short-term investments, plus availability under three revolving credit facilities totaling $2 billion. Liquidity was offset by $324 million of short-term debt and current maturities. The revolving credit facilities have staggered maturities between 2015 and 2017 and are used to back commercial paper. Fitch expects the 2015 revolver will be renewed well before its maturity.

Long-term debt totaled $9.3 billion at March 31, 2014, including current maturities. Scheduled maturities through 2016 total approximately $1.5 billion. The bank credit revolvers and substantially all of Eaton's and Cooper's long-term debt are guaranteed by Eaton Corporation plc and certain of its subsidiaries. Eaton was in compliance with all debt covenants at March 31, 2014.

Eaton's end-markets are generally improving but overall sales growth is modest, reflecting slow global economic growth. The company has balanced exposure to early, middle and late parts of the economic cycle which should smooth financial results over time despite positions in cyclical markets such as aerospace, heavy duty trucks and construction. Performance in Eaton's electrical products and services business are benefiting from the integration of Cooper, including the positive impact of distributor conversions and strong growth in lighting volumes.

In other segments, the aerospace business is well positioned to benefit from high industry production of commercial aircraft expected during the next several years as airlines invest in newer fleets. The company is a supplier on several key commercial and military aircraft and engine platforms in production or in development (e.g. Boeing 787, A320, Leap-X, GTF).

Demand in the hydraulics segment is mixed but has recently experienced strong orders. Eaton's vehicle business could improve modestly in 2014 due to increasing demand in the heavy truck market and the company's position on new automotive platforms.

RATING SENSITIVITIES

Fitch could consider a positive rating action as Eaton rebuilds credit metrics due to the realization of higher sustainable margins, stronger FCF, and additional debt reduction. Financial measures that would be consistent with a positive rating action include a decline in debt/EBITDA toward 2x, FCF/total adjusted debt near the mid-teens compared to approximately 7% as of March 31, 2014, and a reduction in FFO adjusted debt toward 2.5x or below.

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

--Inability to realize expected additional acquisition synergies and margin improvements;

--Unexpected challenges integrating Cooper;

--Cash deployment for share repurchases, legal settlements, or other purposes that materially delays debt reduction or impairs liquidity.

Fitch has affirmed the following ratings:

Eaton Corporation plc

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

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

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

Eaton Corporation

--IDR 'BBB+';

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

--Senior unsecured debt at 'BBB+';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

Cooper U.S., Inc.

--IDR at 'BBB+';

--Senior unsecured debt at 'BBB+'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835480

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings, Inc.

Primary Analyst

Eric Ause, +1-312-606-2302

Senior Director

70 W. Madison Street

Chicago, IL 60602

or

Secondary Analyst

Jason Pompeii, +1-312-368-3210

Senior Director

or

Committee Chairperson

Craig Fraser, +1-212-908-0310

Managing Director

or

Media Relations

Brian Bertsch, New York

+1-212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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