|By Business Wire||
|September 30, 2013 11:26 AM EDT||
Fitch Ratings has affirmed the ratings of Hewlett-Packard Company (HP) and its wholly-owned subsidiary Electronic Data Systems LLC (EDS) as follows:
--Long-term Issuer Default Rating (IDR) at 'A-';
--Short-term IDR at 'F2';
--Senior credit facilities at 'A-';
--Senior unsecured debt at 'A-';
--Commercial paper (CP) at 'F2'.
Hewlett-Packard International Bank PLC
--Short-term IDR at 'F2';
--CP 'at F2'.
--Long-term IDR at 'A-';
--Senior unsecured debt at 'A-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The Ratings and Stable Outlook reflect HP's:
--Strong core credit metrics, with core (non-financing) leverage (core debt/ core operating EBITDA) of 1x as of July 31, 2013 compared with 1.3x in the prior year as significant debt reduction more than offset revenue and profitability pressures. Core interest coverage (core EBITDA/ core interest expense) remains solid at 28x compared with 30x in the year ago period.
Fitch forecasts core leverage will remain below 1x through fiscal 2016 reflecting revenue stabilization, modest EBITDA margin expansion due to restructuring activities and positive revenue mix, and marginal incremental debt reduction.
--Strong liquidity and free cash flow (FCF), consisting of $13.3 billion of cash (primarily offshore), $7.5 billion of undrawn committed credit facility capacity and annual FCF (post dividends) in excess of $5 billion;
Fitch expects HP to generate FCF (post dividends) of $6.5 billion - $7 billion in fiscal 2013 and approximately $4 billion in fiscal 2014. The forecasted decline in HP's fiscal 2014 FCF reflects Fitch's expectations for a 3% decline in total revenue cash usage from working capital contrary to fiscal 2013, and low single digit growth in EBITDA from margin expansion.
--Significant scale and broad portfolio, which provides purchasing leverage for shared components and strengthens the resiliency of its total revenue.
--Strong worldwide market share, including leading unit market share in servers and second largest share in PCs, IT services and networking.
--Significant recurring revenue (33% of total revenue) primarily via printer supplies, outsourcing and technology services, and software maintenance;
--Geographically diversified revenue base with approximately 66% of revenue derived from outside the U.S.;
Rating concerns include:
--Weaker than expected Enterprise Group performance due to market share losses and pricing pressures in industry standard servers (ISS) and significant declines in traditional storage products (tape and EVA SAN), partially offset by new converged storage products (3PAR StoreServ, StoreOnce and StoreAll).
HP's market share losses reflect go-to-market execution issues, a relatively higher exposure to economically challenged Europe, Dell's leading position (65% revenue share) and strong growth in the density optimized server (DOS) market for hyperscale cloud computing, lackluster industry demand for traditional ISS and the success of Cisco's unified computing system (UCS).
In addition to improving execution, Fitch anticipates that HP's competitive and financial position in the DOS market will benefit in fiscal 2014 from the ramping of its Moonshot product, a new class of software-defined servers that is optimized to more efficiently run specific cloud workloads, while consuming less energy, less space, and less cost compared to traditional ISS. Fitch also expects the highly aggressive pricing environment for ISS to moderate.
Fitch believes revenue declines in HP's storage business bottomed in fiscal 2013 and should steadily moderate due to strong growth and increasing scale of its newer converged storage products.
--Continued secular decline in high margin business critical systems (BCS) revenue, which declined 28% in the latest 12 months ended July 31, 2013. HP's technology services revenue and operating margin is also adversely affected as customers gradually migrate to UNIX servers offered by competitors (IBM and Oracle) or x86 servers that have lower attach rates and less profitable support contracts.
--Potential long-term hardware revenue and profitability pressures if commercial customers aggressively adopt cloud computing and the market for cloud services is highly concentrated. In this scenario, cloud providers would have significant pricing leverage due to scale and/or could accelerate their utilization of unbranded custom-built servers.
--Aggressive pricing and weak global demand for PCs due to cyclical factors affecting the commercial PC business and secular factors in terms of tablet or smartphone substitution adversely affecting consumer PC demand. This risk is muted by the low profit contribution of HP's PC business, which Fitch estimates at 7% - 8% of total segment operating profit, despite accounting for 25% of total revenue.
Positively, the majority of HP's PC revenue is derived from commercial customers, where weak demand is attributable to cyclical rather than secular factors. Fitch expects commercial PC demand to improve ahead of Microsoft's end of support for Windows XP in April 2014 given that a significant percentage of commercial customers have yet to transition to Windows 7 (30%-35%). HP has also steadily recovered PC market share in Asia Pacific (APAC) that it lost in late 2011 following a technical issue with a supplier. HP's APAC market share reached 11.5% in the second quarter 2013, the highest since first quarter 2011.
The ratings may be upgraded in the event of:
--Strong revenue growth and expanding margins for the Enterprise Group, which provides greater diversity to the company's operating income mix. Printing accounted for 35% of total segment operating profit in the latest 12 months ended July 31, 2013 compared with approximately 28% in the prior three years.
--Material revenue shift towards software provides margin expansion and greater recurring revenue through subscriptions or maintenance.
The ratings may be downgraded in the event of:
--Continued long-term market share losses in industry standard servers, indicating lackluster demand for HP's new Moonshot servers.
--Significant decline in supplies demand, particularly commercial, which is not offset by growth in other HP segments.
--The company divests any businesses that results in material dis-synergies or EBITDA deterioration.
In addition to its solid cash position and consistent FCF, HP's liquidity is further supported by two undrawn revolving credit facilities, which had aggregate capacity of $7.5 billion as of July 31, 2013, and multiple revolving trade receivables facilities with $838 million of available capacity as of July 31, 2013. HP's revolving credit facilities consist of a $4.5 billion credit facility expiring in February 2015 and a $3 billion facility expiring in May 2017. Minimum interest coverage of 3x is the sole financial covenant.
Total debt was $24.7 billion as of July 31, 2013, consisting of short-term debt of $7.6 billion, primarily current portion of long-term debt ($6.9 billion) and $17.1 billion of long-term debt. Subsequent to July 31, 2013, HP repaid $2.2 billion of long-term debt maturities through Sept. 14, 2013, resulting in $4.7 billion of remaining long-term debt maturities through July 31, 2014. Fitch estimates approximately $10.7 billion, or 47% of total debt, is attributable to HP's customer-financing business.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective from 8 August 2012 - 5 August 2013