Fitch Affirms Exelis Inc. at 'BBB+'; Outlook Revised to Negative
NEW YORK -- October 26, 2012
Fitch Ratings has affirmed the 'BBB+' Issuer Default Rating (IDR), 'BBB+'
long-term debt and revolving credit facility ratings, and 'F2' short-term
rating of Exelis Inc. (XLS). The Rating Outlook is revised to Negative from
Stable. The ratings cover $650 million of long-term debt and the $600 million
commercial paper program. A full list of rating actions follows at the end of
The Rating Outlook revision is driven by the uncertainty surrounding the U.S.
Department of Defense (DoD) budget, including the looming risk of
sequestration, and a deterioration in XLS' underfunded pension position. The
underfunded pension obligation nearly doubled in 2011, reaching approximately
$1.9 billion (66% funded) as of Dec. 31, 2011, and Fitch believes there could
be additional deterioration by the end of 2012 given current interest rate
levels. The size of the underfunded pension liabilities compared to the
company's cash flows from operations is a concern for the ratings. Even though
the deterioration is not expected to have immediate significant cash flow
implications for XLS, it could negatively impact the company's long term cash
The other main factor in the Outlook revision is the outlook for U.S. defense
spending and the looming risk of sequestration. Should sequestration occur, it
may have a significant impact on XLS' operations and cash generation. While
sequestration will negatively impact the whole industry, Fitch believes XLS'
exposure represents a higher credit risk because of a high percentage of
operating cash flows needed to fund required pension contributions. The
recently enacted MAP-21 Act will have a positive short term impact on XLS'
minimum required cash pension contributions; however it affects only the
timing of the cash flows, not the long-term funding requirements.
Fitch's other concerns include:
--Company's exposure to contracts funded by DoD's Oversees Contingency
Operations (OCO) budget;
--Overall declining revenues;
--The shift in the product mix which continues to pressure operating margins.
XLS' ratings are supported by the company's highly diversified portfolio of
defense-related products and services provided to U.S. military and government
customers. XLS has more than 1,000 prime and sub contracts which mitigate the
exposure to a major program cancelation. The company's core businesses focus
on the DoD's high priority programs in information, surveillance and
reconnaissance (ISR), electronic warfare, cyber, and information and technical
services. Additionally, the company benefits from high levels of overall
defense spending and solid credit metrics for the ratings.
Fitch expects the company to maintain solid credit metrics with liquidity
approximately $800 million and leverage (gross debt to EBITDA) within the
range of 0.9x to 1.2x through 2014. Leverage metrics based on FFO instead of
EBITDA are not as strong because of the company's cash generation, including
the impact of pension contributions. Fitch expects FFO Adjusted Leverage to be
in the range of 2.9x to 3.1x.
While XLS had negative free cash flow (FCF - cash from operations less capex
less dividends) of $199 million in the first half of 2012, Fitch expects the
company's FCF for the year to be $125 million to $150 million in 2012, down
from the 2011 level of $220 million due to larger dividend payout. FCF in the
first half was negatively affected by large pension contributions. XLS' cash
deployment strategy is expected to be conservative with approximately $76
million of cash dividends.
After the spin-off from ITT Corporation (ITT), XLS assumed the majority of
ITT's pension obligations, or approximately $5.7 billion as of Dec. 31, 2011.
At that date XLS had a pension deficit of approximately $1.9 billion, or 66%
funded. The other postretirement benefit obligation was $267 million. Through
June 2012 XLS contributed $261 million to qualified pension plans. The company
plans to contribute up to additional $10 million for the remainder of the
year. Fitch believes XLS' pension obligations are manageable due to the
company's solid FCF generation; however the size of the underfunded
obligations and significant funding requirements relative to the overall size
of the company is a rating concern.
XLS generated approximately 87% of its 2011 revenues from the U.S. government,
primarily the DoD. As a result, defense spending is a key driver of XLS'
financial performance and credit quality. High levels of defense spending
currently support XLS' ratings, but the DoD budget environment is highly
uncertain after fiscal 2012 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
The overhang of potential automatic cuts beginning in early 2013 related to
the 'sequestration' situation, as well as the presidential election, 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 XLS'
XLS' sales are not tied to any major program, limiting the company's exposure
to significant cuts for any specific program. Accelerated withdrawal of the
U.S. troops from Afghanistan may have a negative impact on the company;
however it may also benefit XLS by potentially creating new, albeit temporary,
Fitch would not expect modest declines in defense spending to lead to negative
rating action, because XLS' exposure to DoD spending is mitigated by good
liquidity and diversification of its product line. Sequestration-driven DoD
spending declines may lead to negative rating actions for XLS, depending on
the potential impact on the company's cash flow generation as discussed above.
What Could Trigger a Rating Action:
Fitch is not likely to consider a positive rating action given XLS' large
pension liability, declining revenues, margin pressures and uncertainty
surrounding U.S. DoD budget. A negative rating action may be considered if
changes in U.S. defense spending policies have a significant impact on the
company's cash generation.
Fitch affirms XLS' ratings as follows:
--IDR at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Senior unsecured revolving credit facility at 'BBB+';
--Short Term IDR at 'F2';
--Commercial paper at 'F2'.
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.
Applicable Criteria and Related Research:
Corporate Rating Methodology
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
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.
David Petu, CFA
One State Street Plaza, New York, NY 10004
Press spacebar to pause and continue. Press esc to stop.