RE:FitchPress Release: Fitch Downgrades Bombardier to 'B'; Outlook Negative The following is a press release from Fitch Ratings:
Fitch Ratings-Chicago-13 August 2015: Fitch Ratings has downgraded Bombardier Inc.'s (BBD) Issuer Default Rating (IDR) to 'B' from 'B+'. Fitch has also downgraded BBD's long-term debt and bank facility ratings to 'B'/'RR4' from 'B+'/'RR4'. The Rating Outlook is Negative. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The downgrade of BBD's ratings reflects the company's negative free cash flow (FCF), which Fitch expects will be more negative than previously estimated and could be significantly negative through 2017. Development spending remains high for the CSeries, and a delayed entry into service for the Global 7000 until the last half of 2018 is likely to increase total development spending for the program in Fitch's view. Also, BBD has implemented production cuts for the Global 5000/6000 business jets which generate a meaningful share of the company's profitability and FCF. There are additional risks to FCF including aircraft orders that have been weak and the pace of the production ramp-up for the CSeries, which is expected to enter service in the first half of 2016.
Fitch conservatively estimates FCF for all of 2015 will not be materially different compared to negative $1.5 billion generated in the first half of the year. Fitch expects FCF in the last half of 2015 could be near break-even as high costs for the CSeries are offset by an anticipated decline in business jet inventory. Fitch expects FCF could improve in 2016 to approximately negative $800 million due to lower development spending for the CSeries. However, development spending for the Global 7000/8000 program will continue, and the CSeries will be dilutive to margins
Fitch expects liquidity will be adequate through at least 2016 but subsequently could become a concern due to uncertainties associated with cash usage for CSeries production and the level of business jet demand. Fitch believes BBD will be careful about cash deployment and liquidity, but the company could potentially fund restructuring or actions in the near term. Fitch estimates cash could decline in 2017 below $2 billion compared to $3.1 billion at June 30, 2015. Fitch believes BBD can operate temporarily at cash balances below $2 billion, but the company would be exposed to negative developments such as weak demand in the aerospace business or challenges related to the increase in CSeries production that could reduce liquidity or create concerns about compliance with covenants under BBD's bank facilities.
Liquidity would improve if BBD completes a planned initial public offering (IPO) of a minority stake in Bombardier Transportation (BT). Fitch estimates the IPO could generate $1 billion or more of cash proceeds. The transaction would help liquidity but would not address FCF concerns. In the first quarter of 2015, BBD received significant cash proceeds from the issuance of debt and equity. Proceeds totaled $2.3 billion, net of early debt repayment in April 2015 that eliminated material scheduled debt repayments prior to 2018. At the beginning of 2015, BBD suspended dividends on common stock which totaled $160 million in 2014.
The success of the CSeries program is material to BBD's FCF. If initial production is more challenging than expected, or if additional demand for the aircraft does not materialize, BBD may find it difficult to build stronger FCF at a sufficient pace to preserve the company's operating and financial flexibility. Fitch believes BBD is on track for certification by the end of 2015 and first delivery in 2016.
Other concerns include BBD's high leverage, competitive pressure in each of the company's segments, and the risk of CSeries cancellations from customers such as Republic Airways which is contemplating reducing its fleet due to a pilot dispute and other challenges. BBD's high leverage includes debt/EBITDA of 7x at June 30, 2015, which Fitch anticipates will increase due to negative margins associated with early production of the CSeries.
BBD's bank facilities contain various leverage and liquidity requirements for both BBD, including Bombardier Aerospace (BA), and Bombardier Transportation (BT). Minimum required liquidity at the end of each quarter is $750 million for the BBD facility and EUR600 million at BT. BBD does not publicly disclose required levels for other covenants but there is a risk that weaker than expected operating results or an increase in debt could result in noncompliance. The lowest levels of covenant compliance typically occur in the middle of the year instead of at year-end because of BBD's cash flow profile.
BBD has installed a new senior management team since the beginning of 2015, including its CEO and presidents of the Commercial Aircraft and Business Aircraft units. The new management team has broad experience in the aerospace industry and is conducting a full review of BBD's businesses that could lead to additional changes in the company's strategy and operations. BBD has launched a transformation plan intended to improve performance and cash flow.
Fitch views BBD's strong position in the global business jet market as a rating strength. However, margins are weak, especially compared to some other business jet manufacturers such as Gulfstream, and orders in the first half of 2015 have declined from the year earlier period. The decline in orders is due partly to BBD's exposure to emerging markets where demand growth is slowing. BBD's projected EBIT margin for business jets of 5%-6% in 2015 partly reflects the company's decision to cut production of its Global 5000/6000 aircraft compared to elevated levels in 2014 and 2015 that were associated with large fleet orders. The reduced production level would be closer to levels prior to 2014. Fitch believes BBD's Global jets are responsible for the majority of profits in the Business Aircraft segment, so any weakening of industry demand for large jets or in BBD's market position could hinder the company's profitability and cash flow.
BBD's regional aircraft, including regional jets and turboprops, are a smaller contributor to BBD's overall profitability than business jets. Net orders for regional jets were negative in the second quarter and are a concern although they can be lumpy. BBD expects to report EBIT in its commercial aircraft segment, including regional aircraft and the CSeries, of approximately negative $200 million in 2015 as CSeries production increases ahead of first delivery anticipated in the first half of 2016.
BBD is among the global market leaders for regional aircraft. Competition is increasing from new manufacturers which could become a larger threat over the long term and put pressure on future values of BA's used regional aircraft. Aircraft built by new manufacturers, including the Mitsubishi and Sukoi, are primarily directed toward emerging markets but could become more competitive over time.
At BT, low margins reflect project complexity and a highly competitive industry. Margins could improve slightly in 2015, and Fitch expects the ongoing review by BBD's senior management could lead to further growth in margins, although the pace of improvement could be gradual. BT is taking actions to standardize operations across a relatively decentralized business and is focusing on higher-margin services and systems revenue. BT has much lower capital requirements than BBD's aerospace businesses and generates more stable FCF, but the timing of BT's FCF can vary between quarters due to the nature of its contracts.
BT has strong positions in its rail markets, particularly in Europe which represents BT's largest market. The competitive landscape is evolving, however, including several mergers and acquisitions among Asian and European equipment manufacturers. These transactions could exacerbate pricing pressure across the industry and make it more challenging for BT to build stronger margins, which remain below its long-term goal of 8%. BBD's planned IPO of a minority stake in BT could provide flexibility to consider arrangements such as joint ventures or M&A transactions that may strengthen BT's industry position and increase access to emerging markets which will be important to its long term competitiveness.
Rating concerns are mitigated by BBD's diversification and market positions in the aerospace and transportation businesses and a portfolio of commercial aircraft and large business jets which the company has continued to refresh. The company's order backlog at June 30, 2015 totaled $64 billion, or more than three times annual sales.
The Recovery Rating (RR) of '4' for BBD's senior unsecured debt and bank credit facility supports a rating of 'B' and reflects expectations of average recovery prospects (31 - 50%) in a distressed scenario. It is based on Fitch's going-concern analysis of BBD that incorporates the company's established market positions and backlogs at both the aerospace and transportation businesses. The RR '6' for subordinated convertible debt and preferred stock reflects a low priority position relative to BBD's debt.
KEY ASSUMPTIONS
Fitch's key assumptions within its rating case for the issuer include:
--Negative FCF of approximately $1.5 billion in 2015;
--Modest margin improvement at BT is offset by near-term margin pressure in the business aircraft segment and typical margin dilution at the commercial aircraft segment related to entry-into-service of the CSeries;
--CSeries entry-into-service occurs in the first half of 2016;
--Development spending for the CSeries declines in 2016, partly offset by continued spending for the Global 7000/8000;
--Lower orders for large business jets lead to a decline in aerospace deliveries in 2016;
--BT generates slow growth, excluding the impact of foreign currency, and slightly improved EBIT margins.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a negative rating action include:
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August 13, 2015 09:36 ET (13:36 GMT)