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; an increasing portion of revenues derived from international sales; strong liquidity; and large backlog. The company's product portfolio is highly diverse by program, diminishing the risk of large program cuts by the U.S. Department of Defense (DoD). Additionally, the majority of the company's product portfolio is well aligned with the U.S. DoD's priorities.

The ratings and Outlook are also supported by strong cash generation and effective cost management which resulted in margin improvements over the past three years despite annual revenue declines since 2010. Fitch's concern regarding the large pension deficit and corresponding funding requirements could be significantly reduced over the next several years due to the expected net positive cash impact of pension funding driven by FAS/CAS harmonization.

Fitch notes the favorable resolution of the eBorder program between RTN and the U.K. Home Office by an arbitration tribunal, under which the company will receive 185 million pounds from the U.K. government for damages and other monetary relief and 50 million pound reimbursement for drawing on RTN's letter of credit.

Concerns include RTN's exposure to expected declines in core U.S. defense spending in fiscal 2016 driven by sequestration. The concern is somewhat mitigated by rising international sales and by RTN's demonstrated ability to reduce costs to manage lower revenue scenarios.

Fitch's additional concerns include the large pension deficit and its impact on cash flows upon expiration of the Highway Bill and the completion of FAS/CAS harmonization in 2017; cash deployment strategies that include increasing dividends and sizable share repurchases; and the possibility of a sizable acquisition, although the company has not engaged in major acquisition activities over the past five years.

Fitch expects RTN's revenues will decline by low single digits in 2014 as lower sales in the U.S. will offset a sizable increase in the international revenues. Fitch expects RTN's operating margins adjusted for FAS/CAS pension income will be slightly lower in 2014 driven by lower overall sales and the product mix. RTN will continue to execute various cost saving initiatives including reduction in its real estate footprint. The company has already reduced its facilities by approximately one million square feet and expects to achieve square footage reduction of an additional 10% over the next three to four years.

In 2013, RTN's EBITDA margins rose to 14.8% up from 14.6% in 2012. Fitch expects a continuation of rising margins through 2017 mostly driven by a significant positive annual impact of FAS/CAS pension income. Fitch expects adjusted margins, excluding pension impact, to remain relatively flat during the same time frame. The DOD environment remains challenging, but there is more clarity through fiscal 2015 allowing RTN to adjust its cost structure accordingly.

RTN's credit metrics have been stable over the past three years. The company's leverage (debt to EBITDA) remained flat in the range of 1.30x to 1.35x. Fitch expects RTN's leverage to remain in the range of 1.2x to 1.3x over the next several years. FFO adjusted leverage improved significantly in 2013, driven by lower net cash outlays to fund pension liabilities in 2013. RTN's FFO adjusted leverage was 2.0x at the end of 2013, down from 2.7x at the end of 2012. RTN has elevated FFO adjusted leverage for the ratings due to high pension contributions over the past years.

Fitch views RTN's credit metrics as adequate for the ratings, but the company has a small amount of cushion to withstand negative developments at the 'A-' level. Fitch expects the company's leverage and credit metrics will be stable over the next several years with possible improvements to FFO adjusted leverage driven by the anticipated pension related cash inflows from the U.S. government.

As of June 30, 2014, RTN had liquidity of $5.6 billion, including $3.3 billion of cash, $915 million in marketable securities and $1.4 billion of revolving credit facility availability. RTN does not have debt maturities until 2018, when $591 million senior unsecured notes become due. Fitch expects the company will maintain its liquidity near $4 billion in the long-term, but Fitch also believes RTN will likely deploy a part of its currently available cash towards acquisitions or share repurchases by the end of 2014.

FCF (cash from operations less capital expenditures and dividends) for the LTM period ended June 30, 2014, was approximately $1.8 billion, up from $1.4 billion in the prior year driven by lower working capital requirements during the first half of 2014. 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 approximately $1.1 billion on net share repurchases in 2013, up from $731 million repurchased in 2012. 2013 share repurchases are more in line with the historical levels as the company repurchased $1.2 billion net share in 2011. As of June 30, 2014, RTN had repurchased $533 billion worth of net shares, and Fitch expects RTN's 2014 repurchases will exceed those in 2013.

RTN has increased its dividend payout by double digits annually over the past seven years. Fitch expects RTN to maintain its shareholder-friendly cash deployment strategies and continue dividend increases; however, Fitch expects share repurchases to fluctuate based on available cash after the company's acquisition activities. Fitch does not anticipate that RTN will fund share repurchases by debt issuance.

As of Dec. 31, 2013, RTN had a sizable pension deficit of $3.3 billion (85% funded) down from $7.2 billion (71% funded) at the end of 2012. The significant improvement in the funded status of the pension plans was primarily driven by an increase in discount rates in addition to strong asset returns and a total contribution of approximately $1.1 billion in 2013, of which $300 million were discretionary. The domestic PBO was approximately $22 billion at the end of 2013.

Fitch estimates required cash contributions to the company's plans are substantial at $875 million in 2014. The required funded amount decreased significantly (by approximately $450 million before taxes) in 2012 due to the MAP-21 legislation which provided two years of temporary funding relief, and was set to expire in 2014. On Aug. 8, 2014, the President signed the Highway and Transportation Funding Act of 2014 which extended the temporary funding relief through 2017, after which the funding requirement calculations will gradually revert to the previously used measures and will return to pre MAP-21 calculations in 2022.

The large pension deficit and required contributions are mitigated by expected reimbursements from the U.S. government which treats a part of pension costs as allowable and reimbursable costs under some government contracts. The reimbursements from the U.S. government are expected to fully offset the funding requirements over the next several years partially driven by FAS/CAS harmonization. The impact of the harmonization will increase both the company's margins and cash generation.

Fitch expects the funded status of pension liabilities will likely be pressured in both 2014 and 2015 years for the majority of the U.S. companies. Interest rates have declined since the end of 2013, putting pressure on the discount rate and threatening to reverse some of the gains in the funded status. Additionally, the IRS released an exposure draft of new mortality tables which will have a significant negative impact on pension liabilities for the majority of the companies, unless changed. Fitch believes it will likely remain largely intact and will be implemented in 2015, pressuring pension liabilities.

INDUSTRY OVERVIEW

RTN generated approximately 72% of its 2013 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.

U.S. defense spending is projected to remain stable during fiscal 2014 and 2015 at the fiscal 2013 level driven by the Bipartisan Budget Act of 2013 which became law in late 2013. Despite stabilization of the U.S. military spending budget, Fitch expects 2014 to be another challenging year for U.S. defense contractors. The sequestration cuts implemented in 2013 should have a negative effect on most defense contractors for the next several years because of the lag between appropriations and outlays and Fitch expects revenues of most defense companies will decline in fiscal 2014.

RTN's exposure to DoD spending is mitigated by sizable and increasing international military sales, a well-diversified and program agnostic portfolio of products, strong margins, solid FCF, and good backlog. The company's international sales grew by 3% in 2013 and comprised 27% of total sales. RTN expects international revenues to grow to 30% in 2014, partially offsetting declines in DoD spending. International bookings are expected to fluctuate in the range of 35% to 40% of total bookings in 2014. Additionally, the expected sequestration-driven fiscal 2016 revenue declines are incorporated into Fitch's ratings for RTN.

RATING SENSITIVITIES

Fitch would consider a negative rating action if the company's leverage (debt / EBITDA) or FFO adjusted leverage deteriorated and remained within the ranges of 1.5x - 1.7x and 2.7x - 2.9x, respectively, driven by unsuccessful attempts to reduce costs in line with revenue reductions, or aggressive debt funded acquisitions or share repurchases.

Fitch does not an anticipate an upgrade in RTN's ratings because of the current uncertainty in the defense spending outlook and Fitch's expectation that the company's liquidity will decline due to cash deployment to shareholders.

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'.

The Rating Outlook is Stable.

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' (May 28, 2014).

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=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=877774

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