Fitch Affirms Bombardier Inc. at 'B'; Outlook Negative
September 23, 2016 04:09 PM Eastern Daylight Time
CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Bombardier Inc.'s (BBD) Issuer Default Rating (IDR) at 'B' and Long-Term debt and bank facility ratings at 'B'/'RR4'. The Rating Outlook is Negative. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
BBD's IDR of 'B' incorporates significantly negative free cash flow (FCF) that Fitch expects will continue at least through 2018, high leverage, risks associated with the production ramp for the C Series, low industry demand for business jets, and competitive conditions in Bombardier Transportation's (BT) rail equipment business. Fitch expects liquidity will be adequate to fund negative FCF into 2018, assuming at least half of scheduled debt maturities are refinanced, but liquidity will become a larger concern if FCF does not become positive during 2018. There are no material debt maturities before the end of 2017, but $1.4 billion of long-term debt will be due in 2018.
The Negative Outlook considers BBD's negative FCF, potential liquidity concerns related to debt maturities beginning in 2018, and limited financial flexibility and weak operating performance, which reduce BBD's ability to adjust to negative developments. Fitch could consider stabilizing the Outlook if Fitch gains confidence that FCF will become positive by the end of 2018 and BBD effectively addresses future debt maturities.
Rating concerns are mitigated by BBD's strengths, which include: well established market positions in its business jet, regional aircraft and rail transportation businesses, early progress toward building higher margins, high liquidity in the near term, and entry into service of the C Series in mid-2016, which so far is meeting performance targets.
Liquidity has increased materially in 2016 due to $2.5 billion of cash raised from the sale of minority interests in BT and the C Series program. In February 2016 BBD sold a 30% stake in BT for $1.5 billion to Caisse de depot et placement du Quebec (CDPQ), and it sold a 49.5% interest in the C Series program for $1 billion to the Government of Quebec in 2016. BBD's pro forma cash at June 30, 2016 totaled $3.8 billion, adjusted to include all of the proceeds from the C Series equity stake. FCF typically is strongest in the last half of the year, particularly the fourth quarter, and Fitch estimates cash at the end of 2016 could be flat to slightly higher, compared with $3.8 billion at June 30, 2016.
Fitch estimates FCF in 2016 will be negative $1.4 billion, which would represent an improvement from negative $2 billion in 2015. Fitch's estimate is slightly larger than its previous estimate of negative $1.3 billion due to a build-up of C Series inventory associated with late deliveries of GTF engines by Pratt & Whitney. BBD now plans to deliver seven C Series aircraft in 2016, down from its original plan of at least 15 aircraft. Due to the delay and other production risks that are possible, Fitch believes it could be challenging for the C Series to become cash positive by 2020 or 2021 as originally projected by BBD; although it is still early in the production ramp-up and there is time to make adjustments. The C Series has a backlog of 369 orders (329 orders excluding Republic Airways) which is sufficient to support the production ramp through 2020. In 2016, development spending for the C Series is winding down with entry into service for the CS300 planned by the end of the year. However, development spending will remain elevated for the Global 7000 business jet.
Fitch notes that funds from the sale of equity stakes in BT and the C Series support BBD's liquidity, but the transactions also reduce BBD's share of long term earnings in the businesses. The reduction in earnings and dividends from BT will be material while the C Series will generate losses initially. Fitch does not expect to adjust credit metrics related to EBITDA but BT's FCF will be reduced if CDPQ receives cash dividends from the transportation business.
Fitch believes BBD is taking effective actions to improve its operating performance, and several developments could lead to an improved outlook for BBD's results. These include a successful ramp of C Series production, entry into service of the Global 7000 on budget and on time (currently expected in late 2018), a recovery in the business jet market, an effective realignment of BT's operations leading to higher margins (although past efforts have had limited success), and possible additional support from the governments of Quebec or Canada.
Operating concerns include low margins, the weak business jet market and execution challenges at BT which are being addressed through BT's action to streamline the business and realize operating synergies. BBD will incur approximately $250 million to $300 million of charges to reduce its workforce across the company in 2016 and 2017 by 7,000 employees, or roughly 10% of BBD's total headcount. The workforce reductions will be concentrated at BT (3,200 employee reductions) and Aerostructures (2,500 employee reductions).
Other concerns include competitive pressure in each of BBD's segments, the risk of C Series cancellations, and high leverage. An eventual return to positive FCF would help BBD's rebuild its financial flexibility and support the company's plan to de-leverage. However, Fitch believes a meaningful decline in leverage over the long term will be difficult to achieve without a successful ramp of C Series production, timely entry into service of the Global 7000 business jet, higher margins at BT, and a clear plan to address the reduction of earnings and cash flow associated with the minority interests in BT and the C Series. 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.
BBD's bank facilities contain various leverage and liquidity requirements for both BBD, including Bombardier Aerospace (BA), and 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.
Fitch views BBD's strong position in the global business jet market as a rating strength. In the regional aircraft market including regional jets and turboprops, BBD is among the global market leaders, but the segment is a smaller contributor to BBD's overall profitability than business jets.
BBD's low margins in the aerospace business continue to be a concern, and weakness in the large business jet category could hinder BBD's long-term profitability and cash flow. BBD plans to implement furloughs during certain periods in 2017 for its Global 5000 and 6000 business jets to manage production levels. In the near term, aerospace margins will be negatively affected by lower production of global business jets in 2016, and profitability will be pressured by negative margins on the C Series for several years while production ramps up.
BBD has been challenged to generate orders for its regional aircraft and the backlog as of June 30, 2016 was near the lower end of its historical range despite an increase in orders through the first half of 2016. This trend is a concern when considering Embraer which competes with BBD's regional jets and continues to invest in aircraft development.
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. 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%. Revenue was down 8% in the first half of 2016 but segment EBIT was down 2.5%, partly reflecting BT's streamlining of operations and focus 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.
The Recovery Rating (RR) of '4' for BBD's senior unsecured debt and bank credit facility supports a rating of 'B', reflecting expectations of average recovery prospects (31% - 50%) in a distressed scenario. Although Fitch's recovery model produces a Recovery Rating of 'RR3', Fitch assigns an 'RR4' Recovery Rating due to BBD's near-term risks as well as negative earnings and cash flow associated with the C Series until there is better visibility of long-term performance of the program.
The recovery analysis assumes that, in a distress scenario, BT is separated from BBD and is excluded from bankruptcy as BT is relatively independent of BBD's aerospace business. BT is consistently profitable, generates positive FCF and has little outstanding debt, although its use of factoring and forfaiting is substantial. BT's bank facility is not guaranteed by BBD. Under this scenario, Fitch excludes earnings dilution from the C Series during the next few years and assumes a fair valuation is received for BBD's 70% interest in BT, with the value added to BA's stand-alone going concern value. The 'RR6' 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:
--FCF in 2016 will be approximately negative $1.4 billion;
--Business jet deliveries in 2016 decline to 150 aircraft, including 50 large jets, compared to 199 aircraft in 2015;
--C Series deliveries in 2017 increase to at least 30 aircraft following a reduction to the delivery schedule in 2016 associated with delayed shipments of GTF engines;
--The commercial aircraft segment experiences losses for the next several years due production losses on the C Series;
--Development spending declines in 2017 as C Series shifts to production, but development spending for the Global 7000/8000 continues through 2018;
--BT generates slow growth, excluding the impact of foreign currency, and slightly higher EBIT margins.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a downgrade of BBD's ratings include:
--FCF is materially more negative than Fitch's estimated levels of negative $1.4 billion in 2016, declining below negative $1 billion in 2017;
--Cash balances decline below $2 billion before there is a clear path to reach positive FCF;
--C Series production encounters unexpected challenges or delays that increase the program's expected use of cash;
--Weak industry demand in the aerospace business leads to production cuts beyond levels already planned;
--Operating margins deteriorate consistently at BT.
Future developments that may, individually or collectively, lead to a stable Rating Outlook include:
--FCF improves and appears likely to reach a breakeven level by sometime in 2018;
--Steady improvements in segment operating margins, excluding the expected negative impact of C Series production;
--Order rates for business and regional aircraft support high customer advances;
--Consistently lower leverage, including debt/EBITDA below 6.0x.
LIQUIDITY
BBD's liquidity at June 30, 2016 included cash of $3.3 billion plus approximately $1 billion of availability under bank facilities. In addition to a $400 million bank revolver available to BBD and BA that matures in 2019, BT has a separate EUR658 million ($730 million) revolver that matures in 2018 under which EUR100 million ($111 million) was outstanding. BA and BT also have letter of credit (LC) facilities that are used to support performance risk and secure advance payments from customers.
There are no material scheduled debt repayments prior to 2018 when $1.4 billion of debt matures. However, BBD makes significant pension contributions which it estimates will total $300 million in 2016. Net pension liabilities totaled $1.6 billion at the end of 2015, including $959 million at funded plans.
In addition to the two committed bank facilities, BBD has other facilities including bilateral agreements and bilateral facilities with banks and insurance companies. BA uses committed sale and leaseback facilities ($110 million outstanding at June 30, 2016) to help finance its trade-in inventory of used business aircraft. In addition, BT uses off-balance-sheet non-recourse factoring facilities in Europe ($1.1 billion outstanding at June 30, 2016) and forfaiting arrangements with third party advance providers ($435 million at June 30, 2016) in exchange for rights to customer payments on long term contracts at BT.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Bombardier Inc.
--IDR at 'B';
--Senior unsecured bank revolver at 'B'/'RR4';
--Senior unsecured debt at 'B'/'RR4'.
--Preferred stock at 'CCC+'/'RR6'.
The Rating Outlook is Negative.
BBD's debt at June 30, 2016, as calculated by Fitch, totaled approximately $10.8 billion.
SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS
Factoring: BBD's debt includes sale and leaseback obligations and is adjusted for $347 million of preferred stock which Fitch gives 50% equity interest. Fitch also includes usage under factoring and forfaiting facilities and construction advance arrangements, primarily at BT. Fitch's debt calculation excludes adjustments for interest swaps reported in long-term debt as the adjustments are expected to be reversed over time.
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