NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A' long-term and 'F1' short-term Issuer Default Ratings (IDRs) and debt ratings for General Dynamics Corporation (GD). The Rating Outlook is Stable. Approximately $3.9 billion of outstanding debt is covered by these ratings. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Key factors that support the ratings include GD's solid credit metrics, strong free cash flow (FCF; cash from operations less capital expenditures and dividends), financial flexibility and strong liquidity position, competitive position in business jets and defense, and large backlog. Another positive factor is the level of diversity in GD's portfolio of products and services, both domestically and internationally, including marine, ground combat systems and business jet businesses.
GD's conservative financial profile and effective operating strategy helped the company maintain a strong credit profile through the economic downturn. The company has maintained more than $4 billion liquidity over the past five years, increasing it above $5 billion in 2013. The company's leverage fluctuated in the 0.7x - 1.1x range over the past several years, and Fitch expects the company's leverage to remain within the 0.9x - 1.1x range in the near future. Fitch notes GD's solid international and commercial sales which accounted for 34% of revenues in 2012, somewhat mitigating U.S. budgetary pressures and the expected decline in military spending. Fitch expects GD will increase its international and commercial sales in the near future.
Fitch is concerned by declining revenues and corresponding declines in cash generation, which are expected to remain under pressure due to the impact of sequestration and uncertainty of the timing of international orders. GD is exposed to declines in core U.S. defense spending in fiscal 2014 and beyond. A dramatic unexpected change in U.S. defense spending policies would be a key driver of GD's credit profile, although Fitch believes that modest declines in defense spending would not necessarily lead to negative rating actions given GD's current credit metrics, liquidity position, and diversified product portfolio. Fitch is also concerned with the continued weakness in parts of the business jet market.
Additionally, GD has a sizable pension deficit (60% funded at the end of 2012), somewhat mitigated by GD's strong cash generation and the MAP-21 Act enacted in 2012, which has a positive short term impact on minimum required cash contributions to the company's pension plans. Fitch expects pension contributions to remain a sizable part of GD's cash deployment strategy.
At the end of 2012, GD's defined benefit pension plans were $4.9 billion underfunded (60% funded), up from $4 billion (61% funded). The company's pension benefit obligation totaled $12.1 billion at the end of 2012, up from $10.2 billion at the end of 2011. GD contributed approximately $532 million to its pension plans in 2012, of which $100 million was discretionary. The company plans to contribute approximately $600 million to its plans in 2013.
GD generated $1.3 billion of FCF in 2012, down from $2.1 billion in 2011 mostly due to revenue and margin pressures driven by several contract cancelations and sequestration. 2012 FCF was also negatively impacted by the inclusion of approximately $175 million of dividend payments applicable to the first quarter of 2013, which were pulled forward to 2012 because of changes in tax laws. During the first half of 2013, GD reported FCF of $717 million, up from $674 million during the same period in 2012. Fitch expects GD to generate approximately $1.1 billion - $1.5 billion of annual FCF over the next several years.
Acquisitions, share repurchases and dividend payments have been the focus of the company's cash-deployment strategy over the past several years, but GD reduced its share repurchases and acquisition activities in 2012. GD repurchased approximately $602 million worth of shares and spent $444 million on acquisitions in 2012, down from $1.5 billion and $1.6 billion in 2011, correspondingly. Through the first half of 2013 GD repurchased $485 million worth of shares, down from $592 million for the same period in the prior year and had not completed any acquisitions. Fitch's ratings and outlook incorporate expectations of approximately $500 million annually for acquisitions and meaningful cash deployment toward shareholders.
GD participates in two key market channels: defense and business jets. Even though GD's revenues are heavily weighted towards defense, the Aerospace segment typically has the company's highest operating margin.
U.S. government spending trends are key drivers of GD's financial performance as the company generates approximately 66% of its revenues from the U.S. government, mostly from the Department of Defense (DoD). The DoD budget environment is highly uncertain during fiscal 2014 because of the large, automatic spending cuts which went into effect on March 1, 2013. The full implementation of sequestration driven defense spending reductions scheduled to begin in fiscal 2014 will increase pressure on revenues for most U.S. contractors. However, Fitch believes it will not necessarily have a significant effect on credit ratings in the U.S. aerospace and defense sector if companies take actions to offset the impact of the sequester.
The fiscal 2014 budget request submitted by President Obama in April 2013 attempted to avert sequestration cuts for the DoD and stabilize defense spending at the fiscal 2013 budget request level. The fiscal 2014 DoD budget may be significantly reduced from fiscal 2013 levels as the proposal had not been approved at the end of fiscal 2013. The recent shutdown of the U.S. government added significant uncertainties to the DoD spending in fiscal 2014, but Fitch believes congress will either enact a continuing resolution at fiscal 2013 DoD spending levels or will let sequestration play out as the law is written currently when the fiscal 2014 budget will be addressed. Either scenario will result in lower military spending in fiscal 2014. Such uncertainty creates a significant challenge for defense contractors because it impairs their ability to plan appropriate cost cutting measures to counter the potential DoD spending cuts.
Most of the expected spending cuts are from projected budget growth and come off the existing high spending levels. Fitch expects inflation adjusted spending will likely decline, albeit modestly, over 10 years. As an example, Fitch estimates the implemented budget cuts would only reduce base budgets back to the levels seen in fiscal years 2007 or 2008.
Sequestration is incorporated into Fitch's ratings for GD, and Fitch believes that the implementation of sequestration cuts in fiscal 2014 would not lead to negative rating actions given GD's diversified portfolio, long lead times for program execution and solid backlog. Sequestration is expected to impact new awards and Fitch believes GD will be able to adjust its cost structure to maintain profitability. The exposure to DoD spending is mitigated by strong margins, solid FCF, solid diversification within DoD's programs, strong international and commercial sales at a combined 34% of total revenues, and GD's good liquidity. Additionally, the company expects a major increase in international military orders in its Combat Solutions segment in the near future.
GD derived approximately 22% of 2012 revenues from the business jet sector, but the segment had accounted for as much as 25% of sales in recent years. Parts of the business jet market have not yet recovered from the recession and continue to be depressed, but the market is split between larger jets (which are doing well) and mid-size and small jets (which are still under pressure). The business jet sector remains weak overall and is at risk in the event of an economic downturn, and small jets would be most affected.
In 2012, a total of 672 business jets were delivered, equating a modest 3.5% decline and resulting in the fourth consecutive year of declining deliveries since the historical high of 1,313 deliveries in 2008. While overall deliveries were down in 2012, the large and midsize segments did better, as most of the weakness was driven by the lower end of the market. Billings reflect the favorable change in the mix as it declined by only 1% compared to the 3.5% decline in deliveries.
According to General Aviation Manufacturers Association, worldwide business jet deliveries decreased by 4.1% during the first half of 2013. Fitch expects deliveries in 2013 will decrease in the low single digits, but revenues should remain relatively flat with the 1% - 2% potential decrease as the large segment will continue to outperform the overall market.
GD is one of the industry's leaders in large jets. Through the downturn GD maintained profitability and continued developing the G280 and G650 programs, both of which received type certificates in 2012. GD also delivered the first fully outfitted G280 and G650 aircraft to customers in 2012. During the first half of 2013, GD's outfitted deliveries increased from 40 units to 65 units compared to the same period in 2012. The company's green delivers also increased from 54 units to 65 units during the first half of 2013. The majority of the increase was driven by large aircraft deliveries resulting in a significant year over year revenue and profit margin increase in the Aerospace segment.
Fitch may consider a positive rating action should GD improve its credit profile by moderating its cash deployment strategies. Any positive rating action will be conditional on better clarity in U.S. DoD spending plans following fiscal 2014. A negative rating action may be considered if GD completes a large debt-funded acquisition which results in weakening of its credit profile. A negative action is also possible should there be a dramatic change in U.S. defense spending policies and a downturn in the business jet market.
Fitch affirms GD's ratings as follows:
--IDR at 'A';
--Senior unsecured debt at 'A';
--Credit facilities at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage', Aug. 5, 2013.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage