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 $3.4 billion of outstanding debt is covered by these ratings. A full list of rating actions follows at the end of this release.
The affirmation of the company's ratings and Stable Outlook are supported by solid credit metrics, strong free cash flow (FCF; cash from operations less capital expenditures and dividends), financial flexibility and strong liquidity position, competitive positions 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 military and commercial ship building, ground combat systems and business jets. A significant increase in international orders in the Combat Systems segment and orders in commercial shipbuilding further diversified the company's revenue sources in 2014 and first half of 2015.
KEY RATING DRIVERS
GD has a conservative financial profile and an effective operating strategy that helped the company maintain a strong credit profile through the most recent downturn in the business jet sector and sizable reductions in U.S. military spending. The company has significant financial flexibility as it generates above $2.5 billion pre dividend FCF annually, has manageable capital expenditures in the range of 1.5% to 1.8% of sales, and its minimum required pension contributions are a low percentage of funds from operations. GD retired $500 million senior unsecured notes in the first quarter of 2015 which resulted in 0.7x leverage as of July 5, 2015, the lowest level over the past five years.
GD continues to reduce its exposure to the U.S. government by increasing international and commercial sales to 42% in 2014, up from 38% in 2013 and 34% in 2012. The rising commercial sales are fuelled by the increasing sales of the company's business jets which comprise 28% of GD's overall revenues. GD has further diversified its revenues away from the U.S. Department of Defense (DoD) by securing several large international military orders in its Combat System segment.
Fitch expects the Combat Systems segment will stabilize in 2015 and rebound in 2016 driven by increasing international demand and recent program wins. In 2014, GD won a $10 billion award from the Canadian Commercial Corporation to provide military and commercial vehicles, training and support services to an international customer over 14 years (through 2028) via the Combat Systems and IS&T segments. In May of 2015, GD was selected to supply approximately 206 PIRANHA 5 Armoured Infantry Fighting Vehicle to the Danish Armed Forces. In addition, the company has disclosed strong indicative demand for its products from Spain, Switzerland, Iraq, Morocco and many other countries.
GD typically converts 100% of its net income into cash. The company targets 100% of pre-dividend FCF deployment towards shareholders in form of share repurchases and dividends. The company generated $2.4 billion of FCF in 2014, up from $2.1 billion in 2014, driven by improvements in operating margins and improvements in working capital. In the first half of 2015, GD generated $726 million of FCF, slightly up from $721 million generated during the same period in 2014. Fitch expects GD will generate annual FCF after dividends in the range of $1.5 billion to $1.8 billion in the near future. Fitch expects the company will repurchase above $2 billion shares net of dilutions 2015 and $1.5 billion annually thereafter. Additionally, Fitch expects GD will continue steadily increasing dividend payments which are estimated to fluctuate in the range of $850 million to slightly above $900 million over the next two years.
GD's capital expenditures were steady over the past four years and remained within the range of $450 million to $520 million, which translates into the range of 1.4% to 1.7% of sales. Fitch expects the company's annual capital expenditures will slightly exceed $550 million over the next several years driven by the introduction of the G500 and the G600 aircraft and work on the Ohio Class ballistic missile submarine replacement program. Pension contributions are not expected to be material for the company over the next several years. Fitch notes the company has significant financial flexibility to pursue acquisitions.
Fitch is concerned by the uncertainty of the timing of international orders and GD's exposure to possible declines in core U.S. defense spending in fiscal 2016 and beyond. The company is exposed to changes in the U.S. Navy shipbuilding plans as its Marine Systems segment derives a significant portion of its revenues from building Virginia class submarines and DDG 51 (Arleigh Burke-class guided missile destroyers. 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 concerned by the execution risk of successfully delivering the two new large-cabin business jets announced in 2014 (the G500, and the G600). The G500 and G600 are expected to enter into service in 2018 and 2019, respectively. Even though demand for these new models has been robust during the first half of 2015 Fitch expects revenue and margins declines within the Aerospace segment over the next several years due to lower demand for the G450 and the G550 aircraft, high development costs, lengthy certification process and slow ramp-up in production of the new aircraft. Fitch's concerns are somewhat mitigated by a significant backlog for the G650 and the G650ER aircraft as the company has indicated it has flexibility to pull forward production for these aircraft and fill-in a possible production void should the demand for the G450 and the G550 fall dramatically.
GD has a sizable pension deficit somewhat mitigated by GD's strong cash generation. The company's defined benefit pension plans were $3.7 billion underfunded (71% funded) at the end of 2014, down from the 77% funded status ($2.5 billion underfunded) at the end of 2013. The deterioration of the funded status was mostly driven by low interest rates as the company's discount rate of 4.15% in 2014 was significantly down from the 4.95% rate used to measure the liabilities in 2013. Also in 2014, the company adopted updated mortality tables published by the Society of Actuaries, which resulted in a net increase of $566 million in the PBO. Despite a sizable increase of the underfunded status of the pension liabilities, the company's minimum required contributions declined significantly driven by the beneficial impact on pension cash flows resulting from the passage of the Highway and Transportation Funding Act of 2014 (HATFA). GD plans to contribute approximately $185 million in 2015, down from $550 million to its plans in 2014. Fitch believes future cash contributions will not have a significant effect on the company's cash deployment strategy in the near future.
U.S. government spending trends are key drivers of GD's financial performance as the company generates approximately 60% of its 2014 revenues from the U.S. government, mostly from the Department of Defense (DoD). As a result, DoD spending is a key driver of GD's financial performance and credit quality.
The U.S. defense spending environment has been uncertain and under pressure for the past several years. However, the fiscal 2015 budget was likely the trough (base budget and wartime spending), and it should begin rising in fiscal 2016, even under the scenario in which the Sequester (which is still law) is not overridden. The President' base budget request is for $534 billion in fiscal 2016, $34-$35 billion above the Sequester cap. There appears to be support in Congress for spending in line with the President's budget. Fitch's forecasts still incorporate the Sequester.
GD derived approximately 28% of 2014 revenues from its business jet sector, the highest percentage of sales historically. The segment accounted for approximately 41% of the company's operating income, also the highest since the Gulfstream acquisition. During 2014, GD experienced an uptick in aircraft services activity due to the growth in the number of aircraft in service and increased demand for maintenance work. However, trade-in activity declined in 2014, with three pre-owned aircraft sold compared to 11 in 2013. The market is split between larger jets and mid-size and small jets. The larger jet market has continued to perform well, driving the majority of the manufacturing, outfitting, and completions business. The business jet sector remains weak overall compared to its peak, and despite a slight increase in deliveries in 2014 and during the first half of 2015, it is at risk in the event of an economic downturn, with small jets most at risk in Fitch's view.
GD is one of the industry's leaders in large business jets. Through the downturn GD maintained profitability while developing the G280 and G650 programs, both of which were first delivered in 2012. During 2014, GD's outfitted deliveries increased to 150 units compared to 144 units in 2013. The company's green deliveries also increased from 139 units to 144 units during 2014.
In 2014, a total of 722 business jets were delivered worldwide, an increase of approximately 6.5% from the 678 deliveries in the prior year. This marked the second annual increase in deliveries since 2008, when a historic high 1,313 aircraft were delivered.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for GD include:
--Low single digit revenue annual growth beginning in 2015;
--Steady EBITDA margins in the range of 14% to 15%;
--Combined net share repurchases and dividend payments will be slightly above pre dividend FCF which is expected to be above $2.5 billion annually.
--Post dividend FCF margin will remain within the range of 4.5% to 5%;
--Capital expenditures will slightly increase to account for anticipated spending in the Marine Systems and Combat Systems segments. Fitch anticipates capital expenditures will remain steady at 1.8% of revenues, annually;
--Debt level will remain steady and the company will refinance its maturities;
--The company will reduce share repurchases if it makes material acquisitions;
--Pension contributions will not be a significant portion of the company's cash deployment in the near future.
RATING SENSITIVITIES
Fitch would consider a negative rating action if the company's leverage (debt / EBITDA) or FFO adjusted leverage deteriorate and remain worse than the ranges of 1.3x to 1.5x and 2.1x to 2.3x, respectively, driven by a cancelation of key programs, a significant downturn in the business jet sector, or unsuccessful attempts to reduce costs in line with potential revenue reductions. Fitch notes the company has significant financial flexibility and its credit metrics could sustain moderate deterioration without pressuring the current ratings.
A positive rating action is unlikely in the near term due to the Aerospace Segment's cyclical nature and some uncertainty in the U.S. defense spending outlook and its impact on the IS&T segment. Fitch may consider a positive rating action if the company modifies its cash deployment strategy which currently targets a return of 100% of pre-dividend FCF to shareholders in the form of share repurchases and dividends.
LIQUIDITY AND DEBT STRUCTURE
As of July 5, 2015, GD maintained approximately $6 billion total liquidity consisting of $4 billion in cash and full availability under its $2 billion revolving credit facility. Fitch expects the company's liquidity to remain above $5 billion for the next several years or until U.S. DoD and international military spending trends stabilize. GD has historically maintained strong liquidity of greater than $4 billion. GD's liquidity decreased to $6.4 billion during 2014, down from approximately $7.3 billion at the end of 2013 as a result of share repurchases and dividends.
GD's debt structure consists of senior unsecured notes denominated in U.S. dollars. The issuer of the bulk of the debt is the parent company, and the notes are guaranteed by subsidiaries accounting for approximately 86.9% of revenues in 2014. The non-guarantor entities are principally foreign subsidiaries. The next large maturity is in July 2016 when a total of $500 million senior unsecured notes are due. Fitch believes the company will be able to repay these notes with cash on hand, but refinancing is more likely as Fitch expects the company will maintain its current leverage.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
General Dynamics Corporation
--IDR at 'A';
--Senior unsecured debt at 'A';
--Credit facilities at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
The Rating Outlook is Stable
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
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