CHENNAI, India & SINGAPORE--()--Fitch Ratings has downgraded the Issuer Default Rating and long-term ratings for Bombardier Inc. (BBD) to 'BB' from 'BB+'. The Rating Outlook is Stable. A full rating list is provided at the end of this release.
The downgrade reflects BBD's operating performance and negative free cash flow that have been weaker than anticipated due to a slow recovery in Bombardier Aerospace's (BA) regional aircraft and light business jet markets and execution challenges at Bombardier Transportation (BT). The biggest driver of negative free cash flow is high capital spending for development programs at BA, which will continue through 2013 before starting to decline. Fitch anticipates consolidated FCF could potentially be negative into 2013 as capital spending at BA more than offsets FCF at BT, which could return to a positive level on an annual basis in 2013.
At Sept. 30, 2012, debt/EBITDA approached 4.5 times (x) compared to 3.3x at the end of 2011. The increase in leverage reflects $500 million of new debt issued in the first quarter and weaker earnings during 2012. Credit metrics may not improve significantly until the regional aircraft and business jet markets recover and BA gets beyond its peak program expenditures.
Large capital expenditures are centered on the CSeries, but Fitch does not consider the negative impact on FCF at this point in the development cycle to be unusual. Last week, BBD announced a six-month delay to the scheduled first flight of the CS100 which now is scheduled to occur by the end of June 2013, with entry into service one year later. Entry into service by the end of 2014 for the CS300 is unaffected. The change does not increase project costs, but BBD may incur some penalties, and the delay slightly extends the negative cash cycle.
At BA, negative free cash flow includes the impact of a low level of customer advances. Although BA's backlog is at a solid level, many of the orders are for CSeries aircraft or fleet business jets which will be delivered over several years. Capital expenditures at BA totaled $1.3 billion in calendar 2011 and could be near $2 billion in 2012 and 2013. BA cut regional jet (RJ) production in early 2012 due to low industry demand. Demand for regional aircraft reflects a lack of confidence at major airlines about supporting regional air service, concerns about turmoil in Europe, high fuel prices, and airline industry capacity. Demand for large business jets, where BA has its largest presence, is stronger than the light jet market but remains well below peak levels.
At BT, increasing complexity on many projects has contributed to delays in project completion, slower collections, higher inventory, lower margins and negative free cash flow. Cash flow has begun to improve and should be positive in the fourth quarter of 2012. These challenges are being gradually addressed but remain a risk. BT announced it would recognize a restructuring charge of up to $150 million in the fourth quarter of 2012 directed toward cutting costs through layoffs and a plant closure. A large portion of the charge represents cash costs that are expected to occur over 12-18 months. Government spending on rail transportation is under some pressure, but BT's order and backlog remain at solid levels.
BT operates in more stable markets than BA. While not currently anticipated, BT's profile could weaken if funding becomes more difficult for government customers, or if rail equipment providers such as BT are required to participate in risk-sharing agreements.
Rating concerns include the slow recovery in demand for regional aircraft, execution risks at BT, contingent liabilities related to aircraft sales and financing, foreign currency risk, and large pension liabilities. BA's contingent liabilities have been generally stable or slightly lower, except trade-in commitments for used aircraft. These commitments have increased due to the growth in orders for larger business jets. Pension contributions represent a material use of cash. BBD contributed $373 million to its plans in 2011, not including defined contribution plans, and expects to contribute $394 million in 2012. Net pension obligations totaled $2.8 billion at the end of 2011, including $569 million of unfunded plans.
Rating concerns are mitigated by BBD's diversification and strong market positions in the aerospace and transportation businesses and BA's portfolio of commercial aircraft and large business jets, which the company has continued to refresh and should position it to remain competitive when the market recovers.
BA's largest and most important development program is the Cseries, which targets the 100-149 seat segment. BA's ability to recoup its investment and establish a competitive position in the segment will require effective execution, performance of new technologies, and sufficient orders. There are currently 138 firm orders for the CSeries; this is well below BBD's target of 300 orders and 30 customers by the time the CSeries enters service. The level of new orders during the next 12-18 months will be important for the success of the aircraft and BBD's ability to develop a viable market for the aircraft. Other development programs include the Learjet 85 and Global 7000 and 8000 aircraft scheduled for entry into service in 2013 and 2016-2017, respectively.
At Sept. 30, 2012, BBD's liquidity included approximately $2.1 billion of cash and availability under a three-year $750 million bank facility that matures in 2015. In addition, BT has a EUR500 million facility that also matures in 2015. Both facilities were unused. The bank facilities contain various leverage and liquidity requirements for both BA and BT. Minimum required liquidity at the end of each quarter is $500 million at BA and EUR600 million at BT. BBD does not disclose required levels for other covenants. The covenants remained in compliance at Sept. 30, 2012 but could potentially become a concern if BBD's results or liquidity weaken further.
In addition to the two committed facilities, BBD uses other facilities including a performance security guarantee (PSG) facility that is renewed annually as well as bilateral agreements and bilateral facilities with insurance companies. BA uses committed sale and leaseback facilities ($215 million outstanding at Sept. 30, 2012) to help finance its trade-in inventory of used business aircraft. In addition, BT uses off-balance-sheet, non-recourse factoring facilities in Europe under which $1,049 million was outstanding. BA and BT also have LC facilities.
Liquidity is offset by current debt maturities that totaled $46 million at Sept. 30, 2012. In addition to debt maturities, BBD had $520 million of other current financial liabilities including refundable government advances, sale and leaseback obligations, lease subsidies and other items.
WHAT COULD TRIGGER A RATING ACTION
Positive: A positive rating action is unlikely until FCF stabilizes, but future developments that may, individually or collectively, lead to higher ratings include:
--Orders and deliveries improve at BA;
--The CSeries program is executed successfully;
--BT resolves its operating challenges as expected;
-- FCF improves materially as development spending for aerospace programs begin to wind down.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--The CSeries encounters material delays or increased costs;
--Commercial and business jet markets experience an extended period of weak demand;
--Free cash flow fails to improve at BT.
Fitch has downgraded BBD's ratings as follows:
--IDR to 'BB' from 'BB+';
--Senior unsecured revolving credit facility to 'BB' from 'BB+';
--Senior unsecured debt to 'BB' from 'BB+';
--Preferred stock to 'B+' from 'BB-'.
The ratings affect approximately $5.6 billion of debt at Sept. 30, 2012 including sale and leaseback obligations. The amount is before adjustments for $347 million of preferred stock, which Fitch gives 50% equity interest, and the exclusion of adjustments for interest swaps reported in long-term debt as the adjustments are expected to be reversed over time.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 8, 2012;
--'Parent and Subsidiary Rating Linkage', Aug. 8, 2012;
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', Dec. 15, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis