Investing.com -- Moody's (NYSE:MCO) Ratings has revised the outlook for Smiths Group (OTC:SMGZY) PLC (SMIN) to negative from stable, following the company's recent strategic decisions. The Baa2 ratings of the diversified engineering group, including its long term issuer rating, backed senior unsecured rating and the rating of its backed senior unsecured medium term note program, were affirmed.
The change in outlook was announced on February 4, 2025, subsequent to Smiths' decision on January 31, 2025, to implement several strategic actions. These include increasing its share buyback program to £500 million from £150 million in 2025, selling Smiths Interconnect business and returning most of the proceeds to shareholders, and selling or demerging Smiths Detection business after the disposal of Smiths Interconnect.
Moody's decision was influenced by the expected narrowing of Smiths' business profile and uncertainty about its future financial policies, including the balance of debt funding and shareholder distributions. Smiths' Moody's-adjusted debt/EBITDA is projected to rise by nearly 1.0x from 1.4x at FYE 31 July 2024, once both disposals are completed, due to a combination of EBITDA reduction and additional debt. The company's retained cash flow (RCF) is also expected to fall short of Moody's expectation of 25% RCF/net debt in both fiscal 2026 and fiscal 2027.
There is also significant uncertainty regarding regulatory approvals necessary for closing of the transaction, potential divestitures applied to debt reduction, and future financial policy including any changes to the company's current target net leverage of less than 2.0x.
The Baa2 ratings of Smiths still reflect the strong market positions of its business segments in their respective end markets and robust underlying market trends, as well as significant recurring revenue from aftermarket services. The ratings also take into account Smiths' history of maintaining a strong financial profile and conservative financial policy.
However, these strengths are counterbalanced by the company's cyclical exposure, for example, to the mid and downstream oil and gas sector, and material changes in the product portfolio in recent years. The company is expected to become smaller, though more profitable, as a result of the announced strategic actions.
The negative outlook reflects the uncertainty associated with the recently announced strategic actions that could result in a weakened business profile and any mitigating actions that the company may take. The outlook could return to stable if Smiths' reduced scope is offset by more conservative financial policies.
ESG considerations, particularly governance, were a driver of this rating action. Smiths' decision to increase share buybacks materially, as well as to divest two of its four business segments, puts downward pressure on the rating. However, the company's history of robust financial policies supports the expectation that Smiths will balance the interests of its lenders and shareholders prudently.
Smiths Group enjoys ample liquidity, with £459 million of cash at FYE 2024 and an $800 million (£633 million equivalent) undrawn revolving credit facility. The company's only outstanding bond of €650 million matures in 2027.
Despite the announcement of strategic actions and the negative outlook, a ratings upgrade is unlikely over the next 12-18 months. However, the ratings could be upgraded if Smiths increases its scale and improves its end-market diversification, as well as its credit metrics, including Moody's-adjusted debt/EBITDA of less than 1.5x on a sustained basis.
The ratings could be downgraded if there is deterioration in the company's underlying business fundamentals, reflected in EBITA margin below 15%, debt/EBITDA above 2.5x and retained cash flow/net debt below 25%, all on a sustained basis.
Smiths Group plc, headquartered in London, is a UK-listed, diversified engineering group with four divisions generating revenue of £3.1 billion as of FY2024 and operations in 50 countries.
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