Fitch Affirms Raytheon's Ratings at 'A-/F2'; Outlook Stable

Fitch Ratings has affirmed Raytheon Company's (RTN) ratings at 'A-' and 'F2'. The Rating Outlook is Stable. These ratings cover approximately $4.7 billion of debt. A full ratings list appears at the end of this release.

Key Rating Drivers

RTN's ratings are supported by the company's competitive position in the defense industry, good product diversification, a large portion of revenues derived from international sales, strong liquidity, and large backlog. Healthy free cash flow (FCF) generation and increasing international demand also support the ratings.

Fitch is concerned by RTN's exposure to declines in core U.S. defense spending, and uncertainty surrounding the fiscal 2014 Department of Defense (DoD) budget. A dramatic unexpected change in U.S. defense spending policies would be a key driver of RTN's credit profile, although Fitch believes that modest defense spending declines (which are incorporated into Fitch's projections) would not necessarily lead to negative rating actions given RTN's current credit metrics, liquidity position, and diversified product portfolio including international sales.

Fitch's additional concerns include the large pension deficit and its impact on cash flows; cash deployment strategies that include increasing dividends and sizable share repurchases; and to a lesser extent, some pending legal issues, including one with the U.K. Home Office for the termination of the e-Borders program.

RTN's credit metrics have stabilized over the past two years following deterioration in both 2010 and 2011 due to bond issuances that doubled the company's debt from $2.3 billion at Sept. 26, 2010 to approximately $4.7 billion in principal at June 30, 2013. The debt proceeds were used to made discretionary pension contributions of $750 million in both 2010 and 2011 and of $500 million in 2012. Fitch views RTN's credit metrics as adequate even after the debt issuances due to the high level of international sales, high product diversification with low exposure to any given defense program, solid liquidity and strong cash generation. Fitch notes that RTN's cushion to withstand negative developments at the 'A-' level is reduced due to increased leverage over the past few years.

For the last 12 months (LTM) ending June 30, 2013, the company had gross leverage of approximately 1.3x, which was flat versus leverage in 2012. Leverage was 1.2x and 0.7x at the end of 2010 and 2011, respectively. Fitch expects RTN's leverage to increase slightly and to fluctuate within the 1.4x-1.5x range over the next several years driven by expected pressures on the company's revenues and EBITDA.

RTN's liquidity position is one of the key supporting factors for the rating. As of June 30, 2013, RTN had liquidity of $4.9 billion, including $2.5 billion of cash, $1 billion in marketable securities and $1.4 billion of revolving credit facility availability. In 2012, the company refinanced its debt maturating in 2014 and 2015. As a result, RTN does not have debt maturities until 2018, when $251 million senior unsecured notes become due.

FCF (cash from operations less capital expenditures and dividends) for the LTM period ended June 30, 2013, was approximately $1.4 billion. RTN's FCF remained relatively flat over the past two years as the company generated $900 million, $1.1 billion and $1 billion in 2012, 2011 and 2010, respectively. Fitch estimates that RTN will typically generate more than $1 billion of annual FCF.

Dividends and share repurchases have been a significant use of cash in the past several years. The company spent more than $1.2 billion on share repurchases annually from 2007 to 2011. The share repurchases declined in 2012 as the company repurchased approximately $825 million worth of stock. RTN has increased its dividend payout by double digits annually over the past three years (16%, 15% and 21% in 2012, 2011 and 2010, respectively). Fitch expects RTN to maintain its shareholder friendly cash deployment strategies and continue dividend increases, however Fitch expects share repurchases to moderate driven by the decline in company's cash generation due to U.S. defense spending pressures.

RTN has a sizable pension plan deficit of $7.2 billion up from $6.5 at the end of 2011. It was 71% funded at year-end 2012 on the basis of all plans and 72% funded for U.S. plans. The domestic PBO was $23.8 billion at the end of 2012, and the global PBO was $24.7 billion. The large pension deficit is mitigated by the expected reimbursements from the U.S. government which treats a part of pension costs as allowable and reimbursable costs under some government contracts. Required cash funding is substantial, at slightly below $1 billion for the next two years, however the reimbursements from the U.S. government are expected to fully offset the funding requirements. RTN does not expect to make discretionary contributions in 2013 and 2014. The pension plan deficit is expected to decline in 2013 due to increasing interest rates and favorable equity market performance in 2013.

RTN generated approximately 73% of its 2012 revenues from the U.S. government, primarily the DoD. As a result, defense spending is a key driver of RTN's financial performance and credit quality. The DoD budget environment is highly uncertain during fiscal 2014 because of the large, automatic spending cuts which went into effect on March 1, 2013. The full implementation of sequestration driven defense spending reductions beginning with fiscal 2014 will increase pressure on revenues for most U.S. contractors. However Fitch believes it will not necessarily have a significant effect on credit ratings in the U.S. aerospace and defense sector if companies take actions to offset the impact of the sequester.

The fiscal 2014 budget request submitted by President Obama in April 2013 attempted to avert sequestration cuts for the DoD and stabilize defense spending at the fiscal 2013 budget request level. The fiscal 2014 DoD budget will be significantly reduced from fiscal 2013 levels if the proposal does not pass or if another compromise is not reached by October 2013. Fitch believes that there is a high likelihood that the budget proposal will not be approved by the start of FY2014, and Congress will either enact a continuing resolution at fiscal 2013 DoD spending levels or will let sequestration play out as the law is written currently. Either scenario will result in lower military spending in fiscal 2014. Such uncertainty creates a significant challenge for defense contractors because it impairs their ability to plan appropriate cost cutting measures to counter the potential DoD spending cuts.

Most of the expected spending cuts are from projected budget growth and come off the existing high spending levels. Fitch expects inflation adjusted spending will likely decline, albeit modestly, over 10 years. As an example, Fitch estimates the implemented budget cuts would only reduce base budgets back to the levels seen in fiscal years 2007 or 2008.

Sequestration is incorporated into Fitch's ratings for RTN, and Fitch believes that the implementation of sequestration cuts in fiscal 2014 would not lead to negative rating actions given RTN's diversified portfolio, long lead times for program execution and solid backlog. Sequestration is expected to impact new awards and Fitch believes RTN will be able to adjust its cost structure to maintain profitability. The exposure to DoD spending is mitigated by strong margins, solid FCF, solid diversification within DoD's programs and strong international sales at above 25% of total revenues, and RTN's good liquidity.

Rating Sensitivities:

Fitch may consider a negative rating action should there be a dramatic change in U.S. defense spending policies, poor execution on a number of key contracts, and/or a major change in the company's financial strategy. RTN's liquidity position and strong cash generation afford the company some cushion to withstand negative developments at the current ratings. A positive rating action is unlikely in the near term given RTN's leverage, the company's cash deployment strategies, and the current uncertainty surrounding U.S. federal budgets.

Fitch affirms RTN's ratings as follows:

--Issuer Default Rating (IDR) at 'A-';

--Senior unsecured debt at 'A-';

--Bank facilities at 'A-';

--Short-term IDR at 'F2';

--Commercial paper programs at 'F2'.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage', Aug. 5, 2013.

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=715139

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=802555

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