DBRS Downgrades Textron & Textron Financial to BBB (high), Trend Negative

DBRS has today downgraded the Senior Debt ratings of Textron Inc. (Textron or the Company), Textron Financial Corporation and Textron Financial Canada Funding Corp. (collectively, TFC) to BBB (high) from A (low). The trend is Negative. The Commercial Paper ratings have been downgraded to R-2 (high) from R-1 (low), with a Negative trend. With these actions, the ratings are removed from Under Review with Negative Implications, where they were placed on December 23, 2008.

The ratings downgrade primarily reflects the greater-than-expected decline in the operating results of the Company’s manufacturing business, the challenges facing TFC, and the revised near-term outlook. Textron’s coverage ratios are expected to materially weaken from 2008 levels, largely due to lower earnings and cash flow in tandem with continuing high debt levels. The Negative trend reflects the potential that debt (at the manufacturing level) will increase to more aggressive levels should free cash flow deficits arise as a result of weaker-than-expected operating performance and/or heightened funding contributions to TFC.

Slowing economic conditions and the global credit turmoil are largely responsible for the material reduction in earnings expected from Textron’s Cessna unit, which is the key driver of the Company’s operating results (59% of operating earnings in 2008). DBRS had previously expected that Cessna’s large and diversified backlog ($14.5 billion at end-2008) would provide a relatively high degree of earnings and cash flow stability at strong levels through to 2010. However, higher-than-expected order cancellations and deferrals have contributed to the approximate 50% decline in expected operating earnings from the division in 2009. Cessna’s deliveries are likely to be substantially below peak 2008 levels; its higher-margin aircraft will be most impacted by slowing market conditions, with the more economical Mustang business aircraft accounting for a larger share of deliveries. The Company’s Industrial division, which is also highly cyclical, is expected to remain under pressure and contribute limited or no earnings on account of materially lower volumes.

The challenges facing Textron’s manufacturing operations have been compounded by the deterioration in operating results at TFC. The Company’s planned exit from all non-captive finance businesses resulted in a significant ($625 million) capital contribution from Textron to TFC to maintain covenant compliance in Q4 2008, and mainly led to sharply higher leverage. Ongoing capital contributions will be required, albeit at a much reduced level, given that TFC is likely to continue to generate losses as it winds down its non-captive portfolio.

Over the near term, Cessna should continue to generate reasonable operating margins (low double-digit range), and the Company’s less cyclical Bell and Systems divisions also provide a degree of stability to financial results. However, earnings (before non-recurring items) and operating cash flow will be well below 2008 levels. DBRS expects debt-to-capital (including leases) above 50% and cash flow coverage near 20%. Textron is expected to generate modest free cash flow in 2009, despite the severely weakened demand environment, but debt reduction potential is limited and debt is expected to remain high. The Company announced today that it has fully drawn on its $3 billion in available credit, resulting in a $1.2 billion increase in cash after repaying outstanding commercial paper. While Textron’s cash position is enhanced, debt has also increased.

The current macroeconomic and credit environment has significantly reduced visibility and increased the risk of further deterioration in operating results. Weak or negative free cash flow from Textron’s manufacturing operations, combined with additional funding contributions to TFC, would add balance sheet pressure. Increased funding could result from weaker-than-expected collections from TFC’s non-captive portfolio as it is gradually liquidated or reports higher-than-expected losses. In addition, TFC expects that asset sales and other means of financing will be largely sufficient to address maturing term debt ($1.6 billion in 2009), with additional support provided by its large cash position. However, the current distressed credit environment is unlikely to improve over the near term, and DBRS expects that asset sales will be increasingly challenging. In the event of higher debt/reduced liquidity and lower-than-expected liquidations (TFC is targeting $400 million in Q1 2009), this would constrain Textron’s financial flexibility and likely lead to further negative rating action. Alternatively, in the event that operating results at both TFC and Textron stabilize in 2009 in line with expectations, with reduced pressure on TFC’s liquidity position and lower debt at the manufacturing operations, the trend could be returned to Stable.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating the Industrial Products Industry, which can be found on our website under Methodologies.

This is a Corporate rating.