OREANDA-NEWS. Fitch Ratings has downgraded Rockwell Collins Inc.'s (COL) Issuer Default Rating (IDR) and senior unsecured notes to 'A-' from 'A'. Fitch has also downgraded COL's short-term IDR and commercial paper (CP) program to 'F2' from 'F1'. The ratings cover approximately $2.4 billion of long- and short-term borrowings. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS
The downgrade reflects a change in Fitch's expectation for the company's ongoing total debt level and the corresponding negative impact on some of its credit metrics. Fitch previously projected that COL's leverage (debt to EBITDA) would gradually decline to between 1.2x and 1.3x by the end of fiscal 2016, after rising as high as 2.2x immediately following the issuance of debt to finance the acquisition of ARINC Inc., (Arinc) in December of 2013. Fitch currently anticipates that COL's leverage will remain in the range of 1.5x to 1.8x over the next several years, as the company has returned more than 90% of its pre-dividend free cash flows to shareholders through dividends and share repurchases, rather than using excess cash for debt reduction. COL's leverage was approximately 1.7x at Sept. 30, 2015, down from 1.9x at the end of fiscal 2014.

The ratings and the Stable Outlook are supported by the company's strong operating performance and cash generation, including strong EBITDA margins in the range of 23% to 25%; significant diversification of revenue sources and a balanced portfolio within aerospace and defense markets; expected stabilization of the U.S. defense spending environment beginning fiscal 2016; and conservative financial policies. The ratings and Outlook are also supported by the successful integration of Arinc as the company is on track to realize identified pre-acquisition synergies. Arinc's revenues are highly subscription based, diversifying the company's revenue sources and providing better stability to its future sales.

Fitch's concerns include COL's exposure to the highly cyclical business aviation sector; reduced financial flexibility due to the large outstanding commercial paper balance; sizable cash deployment actions towards shareholders; and large pension plan deficit. Fitch does not expect COL to make other large acquisitions in the near future, but small scale acquisitions are possible. The company has a sizable exposure to Bombardier Inc. (BBD, 'B'/Outlook Negative), its largest business jet customer, which has historically accounted for more than 5% of COL's total annual revenues. COL supplies aviation electronics systems and products for various BBD commercial and business jet models, including the CSeries, Challenger Series and Global Series. Significant and unexpected cuts to production schedules of any of the BBD's programs may have a negative impact on the company's operating results.

COL has historically generated strong cash flows. The company reported $749 million of cash flow from operations (CFO) in fiscal 2015, up from $660 million generated in fiscal 2014, an increase mostly driven by the integration of Arinc's operations and an improvement in operating margins. COL's free cash flow (FCF - cash from operations less capital expenditures and dividends) for fiscal 2015 was approximately $358 million, up from $319 million in the prior year. Fitch expects the company's CFO will be in the range of $740 million to $840 million over the next several years. Fitch estimates the company's FCF will also be strong and will remain in the range of $380 million to $480 million over the next several years.

Fitch expects COL will continue deploying more than 90% of its pre-dividend free cash flows to shareholders through dividends and share repurchases. Additionally, Fitch anticipates the company will have sizable cash outlays over the next several years to fund capital expenditures and working capital to support new programs. The company will also likely deploy a part of its cash towards a measured reduction of its short-term borrowings. Fitch does not anticipate pension contributions to be a large part of COL's cash deployment strategy over the next several years.

As of Sept. 30, 2015, COL had a meaningful pension deficit of $1.3 billion (71% funded) up from $0.9 billion (78% funded) as of Sept. 30, 2014. The significant year over year deterioration was mainly driven by new mortality tables released by the Society of Actuaries in 2014.

COL's pension benefit obligations totalled $4.2 billion, and assets were $2.9 billion as of Sept. 30, 2015. The company did not have minimum funding requirements for fiscal 2015, but it made a discretionary pension contribution of $55 million in fiscal 2015. Similarly, COL made a $55 million discretionary contribution to its U.S. qualified pension plan in October 2015. Fitch does not expect pension contributions to be a large part of the company's cash deployment in the near future. Further, the company is not required and does not intend to make any contributions to the ARINC pension plans during 2015.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for COL include:

--Low to mid-single digit annual revenue growth beginning in 2016;
--Steady EBITDA margins at approximately 24%;
--Combined net share repurchases and dividend payments will be in the range of 90% to 95% of pre-dividend FCF;
--FCF margin will remain within the range of 7% to 8%;
--COL will spend above $180 million in capital expenditures, annually;
--The company will not make acquisitions and will maintain steady debt levels. Fitch expects COL will have an average of $500 million in short-term borrowings outstanding throughout the year, with CP balances reducing significantly ($300 million to $400 million) in the fourth quarter and bouncing back in the first quarter;
--Pension contributions will be less than 10% of funds from operations (FFO). Fitch does not anticipate the company will make discretionary contributions for the next several years.

RATING SENSITIVITIES
Future actions that may individually or collectively cause Fitch to take a negative rating action include:
--Increases of leverage above 2x and of lease Adj. Debt / EBITDAR above 2.5x;
--Sustained FFO adjusted leverage above 3x;
--Debt issuance to fund shareholder-friendly activity.

Future actions that may individually or collectively cause Fitch to take a positive rating action include:
--Sustained leverage in the range of 1.2x to 1.3x and lease adj. debt / EBITDAR in the range of 1.5x to 1.75x;
--Sustained FFO adjusted leverage below 2x;
--Continued recovery of the business jet market and higher than expected sales from new platforms such as Boeing 737 Max, F-35 and Bombardier's C series;
--Moderation of short-term debt funded shareholder friendly activities;
--Improved liquidity in the form of higher domestic cash balances and more than 50% availability of the $1 billion revolving credit facility after giving effect to the outstanding CP.

LIQUIDITY
COL has historically maintained strong liquidity of above $1 billion. COL's liquidity declined significantly following the issuance of commercial paper to fund the Arinc acquisition. At Sept. 30, 2015, the company had a liquidity position of $804 million, consisting of $252 million of cash and $552 million of credit facility availability after giving effect to the outstanding CP balance and letters of credit.

Fitch expects the company's liquidity to improve as COL continues to pay down its CP borrowings. COL typically generates the majority of its cash in the second half of the year and repays a large portion of its CP in the fourth fiscal quarter, but Fitch expects the CP balance will increase again in the first quarter of fiscal 2016 due to heavy working capital requirement. Fitch anticipates the company's liquidity will fluctuate in the range of $600 million to $800 million over the next several years. The next large maturity is in December 2016 when $300 million of senior unsecured notes are due. Fitch believes the company will be able to repay these notes with cash generated in fiscal 2016, but refinancing is more likely as Fitch expects the company will maintain its current leverage.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings:

Rockwell Collins Inc.
--Long-term IDR to 'A-' from 'A';
--Short-term IDR to 'F2' from 'F1';
--Senior unsecured revolving credit facilities to 'A-' from 'A';
--Senior unsecured notes at to 'A-' from 'A';
--Commercial paper to 'F2' from 'F1'.