OREANDA-NEWS. Fitch Ratings has revised the Outlook on Netherlands-based diversified manufacturer Royal Philips (Philips) to Stable from Negative. Fitch has affirmed the company's Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at 'A-'.

The revision of the Outlook follows the completion of Philips Lighting IPO. The proceeds were used to repay debt, which bring's Philips's leverage back in line with sensitivities for the current rating.

KEY RATING DRIVERS

Improved Leverage Following Lighting IPO

The revision of the Outlook reflects the improvement in Philips' leverage metrics following the successful IPO of 28.75% of its Lighting business in 2Q16. The IPO proceeds (EUR1.7bn) were used to repay debt, in particular the bridge loan for the Volcano acquisition. As a result, Fitch forecasts funds from operations (FFO) adjusted net leverage to decrease to well below 1.5x in the next years, from 2.9x in 2015. This would bring the company's leverage back in line with sensitivities for the rating.

Continued Focus on Healthcare

Philips has realigned its business in recent years to focus on healthtech. The company changed its reporting structure to reflect its planned strategic separation for Lighting. Full separation of the lighting business (EUR7.4bn sales) could result in Philips becoming more active in M&A in the healthcare sector, which could structurally change profitability margins. The spin-off of the lighting business will reduce diversification, but Fitch believes that exiting this mature, low margin business will be a positive long-term credit driver. The cyclicality of the business will still be offset by the consumer healthcare business, which has been a very stable cash generator for many years.

Healthcare Profitability Still Below Peers

Philips' profitability margins remain below its own targets as well as below its peers (eg Siemens, GE). Margins have been low since Philips voluntarily suspended production at its Cleveland facility at the start of 2014. The re-start of Cleveland should improve profitability, although any improvement will be gradual and slower than expected, which caps Philips' rating at a level below its peers. Fitch also expect Philips' revenue growth to be behind that of its competitors.

Healthy Liquidity

At YE 2015 the company had EUR1.8bn of cash and a EUR1.8bn long-term credit facility that has remained undrawn since it was established in the mid-1990s. This compares with EUR1.7bn of short-term debt maturing in 2016 (this includes the USD1.3bn loan for the Volcano acquisition).

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

Muted organic growth environment in North American and Asian markets.

Group profitability margins to rise but remain subdued by restructuring & separation costs.

Capital expenditure broadly in line with historical levels.

No significant M&A in the forecast period.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to negative rating action include:

- FFO margin below 8% (2014: 3.5%; 2015: 5.1%)

- FFO adjusted net leverage above 1.5x (2014: 4.6x; 2015: 2.9x)

- Free cash flow (FCF) margin below 4% (2014: 2.1%; 2015: 0.9%)

- Fixed charge cover below 6x (2014: 3.3x; 2015: 5.1x)

Future developments that may, individually or collectively, lead to positive rating action include:

- FFO margin above 10%

- FFO adjusted net leverage below 1x

- FCF margin above 5%

- Fixed charge coverage above 8x