DBRS Confirms Textron at BBB (low), Changes Trend to Stable

DBRS has today confirmed the ratings on the Senior Debt of Textron Inc. (Textron or the Company), Textron Financial Corporation and Textron Financial Canada Funding Corp. (collectively, TFC) at BBB (low), and the Commercial Paper ratings at R-3. The trends have been changed to Stable from Negative, where they were placed on April 29, 2009. The rating action reflects the expectation for stability in Textron’s financial profile over the near term, and the reduced risk associated with the liquidation of TFC’s non-captive managed receivables portfolio. The ratings take into account Textron’s leading market positions and consistent free cash flow generation from its manufacturing operations, as well its high debt levels and earnings volatility.

Textron’s financial profile is expected to be relatively stable over the coming year, with credit metrics more in line with the current ratings in 2011. The previous Negative trend reflected the uncertainty regarding the downside to the Company’s financial results, namely related to its Cessna division (historically the largest share of total earnings) and TFC. While Cessna’s margins are expected to be low through 2010, business aircraft industry conditions appear to have stabilized and are expected to improve beyond this year, mainly as demand recovers from trough levels. Combined with continuing solid performance from its Bell and Systems divisions and current/planned efficiency initiatives, the risk for further material downside to earnings and cash flow is much reduced. In addition, the liquidation of TFC’s non-captive portfolio has proceeded ahead of expectations at a high rate of cash conversion and is expected to continue at somewhat lower cash conversion rates.

The Company is expected to generate free cash flow from its manufacturing operations in 2010, likely in the $500 million range. Free cash flow is expected to be used toward the repayment of TFC term debt (to cover any amounts not covered by planned portfolio liquidations) and Textron term debt. Given the expectation for relatively flat earnings and cash flow from operations over the next year, and the modest amount of Textron debt maturing in 2010, the credit metrics of the manufacturing operations are likely to be relatively stable over the near term. However, over the medium term, Cessna is expected to drive stronger operating results, which should result in core credit metrics that are more appropriate for the current rating.

DBRS notes that current coverage and leverage ratios are relatively aggressive for the rating, including adjusted debt-to-EBITDA of over 3.0 times. However, this is partly due to the large increase in debt resulting from a series of capital market transactions and credit facility drawings that were executed to secure access to liquidity in an uncertain credit environment. On a net basis, credit ratios are solid as Textron’s cash position is significant ($1.75 billion at end-2009). In addition, the Company’s credit metrics are not materially below DBRS’s expectations, which would have made a rating downgrade more likely. Furthermore, liquidity is no longer viewed as an issue, given the large cash position (close to the amount of maturing consolidated debt in 2010), and the expectation for manufacturing free cash flow and further TFC portfolio liquidations (roughly $1.6 billion is targeted for 2010).

DBRS notes that upside to the rating is limited over the near term and the Company continues to face several headwinds. Weaker-than-expected macroeconomic conditions and corporate profitability (highly correlated with business aircraft shipments) add downside risk to earnings and cash flow. Business aircraft demand has historically lagged economic recoveries by roughly two years, and this is expected to remain the case. At TFC, losses are expected to continue as it winds down its non-captive portfolio and lower-than-expected collections could reduce available liquidity. While not viewed as likely, in the event that the Company’s operating performance materially weakens and/or its debt position does not improve, a negative rating action could be considered.

Notes:
All figures are in Canadian 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.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com