HP Credit Rating Cut by Moody’s, Put on Negative Watch
Moody’s said that while HP will remain the leader in several market segments for the time being, its “credit profile will remain weaker than previously expected over the intermediate term.”
HP’s debt load, and the expenses it incurs to borrow, have become an ongoing concern; over the summer, credit default swaps on its bonds — essentially the insurance that debt investors buy to protect against the possibility of a default — were “blowing out,” as the term of art goes.
The end result of downgrades like this is that when HP next goes to the debt markets to borrow money to finance some aspect of its operations, it will probably have to incur higher costs to do it.
It was the second downgrade on HP’s credit rating by Moody’s this year. The last one was in January. Previously, both Fitch and Standard and Poors cut their ratings on HP late last year. Fitch has had a negative outlook on HP since then.
One thing HP doesn’t have is downgrade triggers on any of its debt. Sometimes companies have triggers written into their debt agreements that have the effect of accelerating the maturity dates by which the debt has to be repaid. But, as HP conceded in its most recent 10Q filing with the U.S. Securities and Exchange Commission, the downgrades already incurred have increased the cost of borrowing and overall reduced its capacity to borrow.
HP does have pretty ample cash reserves, and Moody’s even says as much in its announcement: $11.3 billion in cash and equivalents as of the end of the most recent quarter, and it said it expects that level to remain north of $8 billion for the forseeable future. Add to that an expected $4 billion in free cash flow in 2013, and it makes it unlikely that HP will need to borrow anytime soon.
Another bit of good news for 2013 is that HP has about $5.5 billion in debt maturities due, starting with a $1.5 billion payment in March and additional payments due in May, August and September. But there’s another $8 billion and change due in the following two years. Some will be repaid, some refinanced.
Whatever the outcome, today’s downgrade is a step in the wrong direction from what CFO Cathie Lesjak talked about at HP’s analyst’s meeting in San Francisco last month. At the time, she said getting HP back to what she called a “Mid Single-A” credit rating is “a top priority for us.” The only way to do that, she said, was to reduce the net debt load of the operating company — the portion of the debt not held by the finance division that is there to help customers buy HP gear — to “roughly zero.” That will take time.
Here’s the full announcement, courtesy of Moody’s:
Rating Action: Moody’s lowers Hewlett-Packard’s senior unsecured rating to Baa1, outlook negative
Global Credit Research – 28 Nov 2012
Approximately $25 billion of debt securities affected
New York, November 28, 2012 — Moody’s Investors Service lowered the long term credit ratings of Hewlett-Packard (HP), including the senior unsecured rating to Baa1 from A3. The Prime-2 short term rating is affirmed. This concludes a review initiated October 4, 2012. The outlook is negative.
The new rating reflect our expectations that “although HP will maintain strong to leading positions in a number of product areas, the company’s credit profile will remain weaker than previously expected over the intermediate term,” said Moody’s senior vice president, Richard Lane.
The negative rating outlook reflects our concerns about HP’s ability to contend with the significant competitive, secular and execution challenges facing the company. A “broad portion of HP’s portfolio, including PC’s, some enterprise servers, printers, and services, representing over 75% of revenue, will face slow to no growth prospects over the coming years,” said Lane. The ability to restore growth and profitability has sufficient uncertainty that we believe event risk in the form of more shareholder friendly actions or portfolio repositioning could develop, which would pressure the company’s credit ratings.
Key drivers to the projected credit profile include “company-specific execution challenges in services and software, secular shifts in PCs and printing, competitive pressures throughout its broad portfolio, as well as a cautious demand environment,” said Lane. As a result, we expect HP’s revenue will decline 5% next year while operating margins approximate 7% as compared to a nearly 9.8% historical average prior to 2012 (using Moody’s standard adjustments). We also anticipate free cash flow (post dividends) of approximately $4 billion next year, down from our prior expectations of $6 billion to $7 billion, driven by restructuring related cash outflows and overall weaker operating performance.
We believe HP will remain committed to reducing gross debt over the intermediate term after having reduced debt by $2.2 billion in 2012. We anticipate HP will repay at least half of its debt maturities over the next few years. In fiscal 2013, debt maturities total $5.5 billion with $1.5 billion due in March, $1.75 billion in May and $1.1 billion in each of August and September. HP has $4.9 billion and $3.2 billion of debt maturities in 2014 and 2015. Assuming HP repays approximately half of its debt maturities and refinances the rest, we project HP’s adjusted debt to EBITDA, estimated at 2.0x at October 2012, will approximate 1.9x at the end of 2013 and potentially 1.6x by 2015.
Ratings lowered include:
senior unsecured rating to Baa1 from A3
subordinated rating to (P)Baa2 from (P)Baa1
preferred rating to (P)Baa3 from (P)Baa2
Rating outlook negative
We expect HP’s acquisition activity will be minimal over the next few years as management focuses more on internal research and development over acquisitions, where HP has demonstrated a poor track record. While the less acquisitive posture reduces event risk, this approach also raises the potential that HP could lose some competitive ground against peers who have more flexibility to get to market faster with products and technology offerings via acquisition.
HP maintains a solid liquidity profile. At the end of October 2012, HP had $11.3 billion of cash and equivalents and we expect HP will maintain cash balances in excess of $8 billion. While a significant portion of this cash is held offshore, the company has tax efficient access to material amounts of this cash. We project about $4 billion of free cash flow in 2013, with the first half being weaker than the second half due to some seasonality and heavier restructuring cash outflows (primarily headcount).
The company maintains solid alternate liquidity to support outstanding commercial paper ($574 million at July 2012) in the form of a $4.5 billion bank facility maturing February 2015 and a $3.0 billion bank facility maturing March 2017. Both have one financial covenant under which HP has ample room, and no need to represent as to no material adverse change.
HP’s ratings are unlikely to be raised over the next year. The rating could be stabilized over the 12 to 18 months if the company demonstrates consistent execution and progress in restoring sustainable profitability throughout its portfolio. Longer term, the ratings could be raised if the company: (1) demonstrates steady organic revenue growth; (2) is likely to sustain EBIT margins above 9%; and (3) adheres to its conservative financial practices which include maintaining significant liquidity and a modestly leveraged balance sheet such that adjusted debt to EBITDA were below 1.5x on a sustained basis.
HP’s ratings could be lowered if the company (1) maintains adjusted debt to EBITDA above 2.0x; (2) EBIT margins fall below 6% for an extended period of time; or (3) deviates from our expectations of conservative financial practices.
For further information, please see www.moodys.com.
Hewlett-Packard, headquartered in Palo Alto, California, with $120 billion in revenue for the twelve months ended October 2012, is the world’s largest technology firm by revenue that designs, manufactures, and services computing and imaging systems and provides information technology and consulting services.
The principal methodology used in rating Hewlett Packard was the Global Technology Hardware Industry Methodology published in September 2010. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
The Global Scale Credit Ratings on this press release that are issued by one of Moody’s affiliates outside the EU are endorsed by Moody’s Investors Service Ltd., One Canada Square, Canary Wharf, London E 14 5FA, UK, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that has issued a particular Credit Rating is available on www.moodys.com.
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