TEXT - S&P cuts Bombardier rating to 'BB'
Overview -- We are lowering our long-term corporate rating on Bombardier Inc. to 'BB' from 'BB+'. -- The downgrade reflects what we view as the company's significantly lower-than-expected cash generation in 2012 due to fewer customer advances and weaker operating profit given the global economy. This, combined with ongoing heavy capex on the C-Series programs (which are facing a six-month delay), will mean that Bombardier's leverage ratio will remain high, over 6.0x, until 2014. -- We are also assigning our 'BB' issue rating, and '4' recovery rating, to Bombardier's proposed US$1 billion of unsecured notes. -- The stable outlook reflects our expectations of stable performance from the company's rail segment and overall slight improvement in operating margins. Rating Action On Nov. 14, 2012, Standard & Poor's Ratings Services lowered its long-term corporate rating on Bombardier Inc. to 'BB' from 'BB+'. The outlook is stable. The downgrade reflects what we view as the company's significantly lower-than-expected cash generation in 2012 due to fewer customer advances and weaker operating profit given the global economy. This, combined with ongoing heavy capex on the C-Series programs (which are facing a six-month delay), will mean that Bombardier's leverage ratio will remain high, over 6x, until 2014. Standard & Poor's also assigned its 'BB' issue rating, and '4' recovery rating, to the company's proposed US$1 billion of unsecured notes. The '4' recovery rating reflects average (30%-50%) recovery in a default scenario. Rationale The ratings on Bombardier reflect what we view as the company's satisfactory business risk profile and aggressive financial risk profile. Our ratings take into consideration the company's leading market positions in the transportation and business aircraft segments, its good cost efficiency, and increasing product range and diversity. These positive factors are partially offset, in our opinion, by the financing pressure Bombardier's customers face in the aerospace and transportation divisions, significant execution risk in the launch of its upcoming CSeries jet, increasing leverage, and weakening cushion under the financial covenants. Bombardier is engaged in the manufacture of transport solutions worldwide. It operates in two distinct industries: aerospace and rail transportation. It has 69 production and engineering sites in 23 countries, and a worldwide network of service centers. The company is a market leader globally in rail, especially in Europe, which is considered the largest market for rail at about 60%. Bombardier is also considered to have the largest market share in the business jet segment at about 37% and the second-largest in the commercial jet segment (about 38%). These businesses have high barriers to entry and require substantial investments in capital, technical, and project integration skills, as well as a reputation building. We believe Bombardier offers a comprehensive range of business aircraft of different sizes, and that its transportation division has a well-established track record in Europe, with increasing order acquisitions in the more rapidly growing Asian markets. This provides credit strength in our assessment of the company's competitive position. We believe that Bombardier's transportation business has provided crucial support to the company's cash flows and expect this to continue until there is a more sustained meaningful recovery in its aerospace business. We are concerned that delays in deliveries, as seen in 2011, or reduced customer advances due to the weak global economy could reduce cash flows from the transportation division. We expect the unit's book-to-bill ratio to remain over 1x this year and the backlog to remain at about three years as European countries continue to invest in their rail infrastructure despite the current economy. While the transportation division has a large exposure to Europe, it has limited (below 10%) exposure to Portugal, Spain, and Italy, and most of this is for service contracts. The division does not have any contracts with Greece. The company's regional jet business has been performing below expectations with an EBIT margin of below 6%. For the first nine months ended Sept. 30, 2012, orders for commercial aircrafts were up slightly from the previous year (138 versus 133), while deliveries were about half of those in 2011 (34 versus 67). While business jet orders have been in line with expectations, customer advances have been lower, which is a key source of liquidity to help fund heavy capital expenditure related to the CSeries programs. Further constraining the business is the development of the CSeries aircraft, expected to be delayed by six months mainly due to supplier issues. The company now expects the first flight for the programs in mid-2013. Although Bombardier expects no significant increase in capex related to recently announced delays to the CSeries programs, Standard & Poor's recognizes that additional delays could lead to order losses and an increase in capex. The CSeries orders have been below our expectations, with 138 firm orders so far. The company is maintaining its target of 300 firm orders by the time of launch. However, it will have to directly compete against Boeing Co. (A/Stable/A-1) and Airbus (not rated) in this category. On the business jet front, Bombardier continues to hold a leading position in the industry, which was hard hit in the 2008-2009 economic downturn. The industry has begun to recover, with increasing order flow and lower cancellations, and we believe Bombardier continues to maintain market share. However, overall demand for new aircraft will likely remain low due to the lingering effects of the global recession and a growing used business jet market. It might be several years before demand returns to pre-recession levels. We consider the company's financial risk profile as aggressive. While we believe that management is committed to a moderate financial policy, weak cash flow generation and heavy capex have resulted in weakening credit metrics. Furthermore, the decrease in the discount rate related to pensions has resulted in a significant increase in the company's pension deficit, leading Standard & Poor to adjust the debt for pension deficit to US$2.3 billion for 2011 from US$1.3 billion in the previous year. As a result, our adjusted leverage ratio is 6.9x as of Sept. 30, 2012. Even if we were to remove the effect of the lowered discount rate, adjusted leverage would be about 6x. Given weaker-than-expected performance year-to-date, expectations of lower order intake in 2013 and 2014 than previously forecast, and issuance of new debt, we expect leverage to be about 7.0x at the end of 2012 and gradually improve in the next two years to 4.5x-5.0x. Our forecasts are based on following assumptions: -- Consolidated revenue to decline by about 7.5% in 2012 and rise by about 4.5% in 2013; -- EBITDA margins to be 7.6% in 2012 and improve to 8.2% in 2013; -- The company issues US$1 billion of notes; and -- Free cash flow usage to be about US$500 million in the next two years and to become positive in 2014. Our cash flow protection levels as measured by funds from operations (FFO) to total debt are below 15% and likely to remain there for the next couple of years. These ratios do not take into account the nearly US$2.1 billion of cash on the company's balance sheet as it is used for working capital needs. Liquidity We view Bombardier as having adequate liquidity. While sources are expected to exceed uses by more than 2x in the next 12-24 months, we expect the headroom under the company's leverage covenant to be below 30% in 2012, which does not meet the threshold for strong liquidity under our criteria. While we expect the cash position to improve in 2012 as the company works through delayed deliveries from 2011, we are concerned that further delays in deliveries, as seen in 2011, or a decline in customer advances, could further constrain liquidity in light of expected large capital expenditure in the next two years. The company's cash position has declined by about US$1.2 billion in the first nine months of 2012. Furthermore, the company's issuance of US$1 billion of notes will shore up additional liquidity to help fund large capex on the CSeries programs. The company's debt maturity profile is favorable with no major debt due until 2016 other than the US$161 million notes maturing in 2014, which we expect the company to refinance as they come due. Recovery analysis For the complete recovery analysis, see the recovery report on Bombardier to be published on RatingsDirect on the Global Credit Portal following this report. Outlook The stable outlook reflects our expectations that the company will have sufficient liquidity between the proceeds from bond issuance and positive cash generation from it rail segment to fund heavy capex related to the CSeries programs. While the company will likely generate strong cash flows from operations in the next two years, the heavy capex related to the CSeries will mean debt levels will remain flat. We do expect leverage to improve but to remain above 6x until 2014. A further downgrade is possible, if lower customer advances and additional delays in the CSeries programs lead to greater-than-expected negative free cash generation. This could ultimately lead to delays in any improvement to the adjusted leverage ratio from our current expectations in the next year-and-a-half. Under the current business conditions, we believe an upgrade is unlikely in the near term. Nevertheless, when what we view as more normal and stable market conditions return and the company successfully launches the CSeries, we could consider revising the outlook to positive or raising the rating on Bombardier if in turn the company improves its financial measures, with adjusted debt to EBITDA falling below 4x or adjusted FFO to debt reaching 20%. Related Criteria And Research -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Methodology And Assumptions On Risks In The Aerospace And Defense Industries, June 24, 2009 Ratings List Ratings Lowered/Recovery Rating Unchanged To From Bombardier Inc. Corporate credit rating BB/Stable/-- BB+/Stable/-- Senior unsecured BB BB+ Recovery rating 4 4 Ratings Assigned Bombardier Inc. US$1 billion sr unsecured debt BB Recovery rating 4 Ratings Affirmed Bombardier Inc. Preferred Stock Canada scale P-4 Global scale B+
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