NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB+(EXP)' rating to Northrop Grumman Corporation's (NOC) proposed senior unsecured notes. NOC plans to issue 10-year senior unsecured notes that will rank equally with the company's existing unsecured notes. The proceeds from the debt issuance will be used for general corporate purposes, including debt repayment which may include redemption of the remaining $200 million of 6.75% senior unsecured notes due 2018 by Northrop Grumman Systems Corporation (NGSC), NOC's wholly owned subsidiary. Fitch expects the size of the issuance will be less than $1 billion.
NOC's existing ratings are listed at the end of this release. The Rating Outlook is Stable. The ratings also apply to NGSC. Fitch's ratings of NOC will cover up to $7.2 billion of long-term debt after giving effect to the proposed senior unsecured notes and the redemption of the $200 million senior unsecured notes by NGSC. Similar to the company's other existing senior unsecured notes, the proposed notes will be governed by the indenture dated as of Nov. 21, 2001.
KEY RATING DRIVERS
NOC's ratings are supported by a highly diversified defense portfolio, strong margins, high level of U.S. defense spending and solid financial flexibility. The company has adequate credit metrics for the rating, despite a slight deterioration of leverage (debt/EBITDA) over the past two years primarily driven by an issuance of $600 million senior unsecured notes to fund a $500 million discretionary contribution to pension plans.
Fitch expects NOC's leverage metrics will deteriorate further with the issuance of the proposed senior unsecured notes, and any further material weakening of the metrics could potentially pressure the ratings. Fitch estimates the company's leverage (debt to EBITDA) will increase to approximately 1.9x-2.0x immediately following the issuance of the notes up from 1.8x as of the last 12 months (LTM) ended Sept. 30, 2016 (depending on the final size of the offering). Similarly, FFO adjusted leverage is expected to deteriorate to approximately 3.0x-3.1x, up from 2.2x as of LTM Sept. 30, 2016.
Fitch expects NOC's leverage will decline to approximately 1.8x at the end of 2017 and below 1.6x at the end of 2018 primarily driven by anticipated increases in the company's earnings and EBITDA and NGSC's anticipated $200 million notes due 2018. In addition, Fitch believes a part of the proceeds from the current debt offering may be used to repay a portion of $850 million of senior unsecured notes due in 2018. Fitch expects the company's credit metrics will be adequate for current ratings over the rating horizon.
NOC has significant growth opportunities in its Aerospace Systems segment driven by anticipated increases in production rates for several programs. The company expects to start low-rate initial production for the Triton program and increase the production rate on the E-2D Advanced Hawkeye aircraft. NOC also expects to benefit from the F35 program, which should reach full-rate production by 2019. The anticipated growth will be further complemented by the development work on the recently won B-21 program. Higher volumes from these programs will be partially offset by further production cuts of the F-18 aircraft which have already reduced segment revenue by approximately $400 million and overall revenues by approximately $600 million per year.
NOC has historically generated strong cash flows. As of the last 12 months ended Sept. 30, 2016, the company generated $1.5 billion of free cash flow (FCF). Fitch expects NOC will generate FCF in the range of $1 billion to $1.3 billion annually despite elevated CapEx over the next two to three years. NOC's FCF is seasonal, and the company generates the majority of its cash during the second half of the year. Large swings in quarterly working capital requirements and operating cash flow are offset by NOC's solid liquidity.
Similar to most defense contractors, NOC is focused on increasing its international sales, which accounted for approximately 14% in 2015. The company anticipates a sizable increase in international sales due to higher global demand for its unmanned aircraft and a ramp-up of F-35 production. An increase in aircraft sales to international customers should eventually translate into service and aftermarket revenue in the Technology Services segment when aircraft systems require sustainment and modernization.
In October 2015, NOC won U.S. Air Force's B-21 contract which is expected to replace the B-52 and B-1 bomber fleets with a targeted production of 80 to 100 aircraft. The contract is expected to exceed $55 billion over the life of the program but there is a high level of secrecy around it.
Fitch expects the B-21 contract will not have a meaningful financial impact on the company for the next two to three years as the development and initial testing phases for such programs take significant time. Over the long term, B-21 will become NOC's largest contract and will most likely pressure overall operating margins over the next five to six years due to low margins typically associated with new development programs. Margin pressures could be partially offset by the scheduled conversion of several of NOC's programs from development into higher-rate production.
Rating concerns include NOC's exposure to potential cuts to the U.S. defense budget which may negatively affect the F35, the Global Hawk, and the Triton programs. The concern is mitigated by increased U.S. defense spending in FY2016 and FY2017. U.S. defense spending has increased in FY2016 due to higher investment spending after a three-year trough. Three agreements between the White House and Congress have provided relief from the Budget Control Act (BCA) of 2011, but projected spending beyond FY2017 is above the budget caps, so caps remain a risk through 2021. Fitch bases its defense ratings on the assumption that the caps will continue to be overridden. The results of the recent U.S. elections could drive an update to Fitch's forecast.
Approximately 86% of the company's consolidated debt will be issued by the holding company (NOC) after giving effect to the proposed senior unsecured notes and the redemption of NGSC's $200 million notes due 2018, with the rest issued by NGSC. NOC's bonds are structurally subordinated to NGSC's debt because there are no upstream guarantees from NGSC, but Fitch does not consider the difference to be great enough for the NOC's ratings to be lower than the operating subsidiary's ratings.
Fitch's key assumptions within the rating case for NOC include:
--Mid- to high-single-digit revenue growth beginning 2017;
--EBITDA margins in the range of 15.5% to 16%;
--Share repurchases subside to approximately $1.2 billion annually beginning 2016;
--FCF margin will dip slightly in 2016 to approximately 4%; however, will rebound and remain steady at approximately 5% beginning in 2017.
--Capital expenditures will fluctuate in the range of $0.8 billion to $1 billion over the next three years;
--The company's leverage will return to 1.8x by the end of 2017 due to anticipated growth in revenues and EBITDA. Leverage will remain in the range of 1.6x to 2.0x over the next two years and the company will refinance maturities as they come due;
--The company will not make acquisitions;
--The company will not have significant tax deferrals;
--The company will contribute approximately $100 million to its pension plans annually.
Fitch does not anticipate a positive rating action in the near term given current credit metrics and the company's significant share repurchases. Positive rating actions could be considered if the company modifies its cash deployment strategy and focuses on debt reduction.
Negative rating actions may be driven by issuance of additional debt to fund share repurchases or acquisitions; if the company experiences significant performance issues on large contracts; or if there are material unexpected changes in U.S. defense spending trends. Fitch will likely consider a negative rating action if NOC's leverage (debt to EBITDA) increases and remains above 2.0x or if the company's FCF margin declines and remains below 3.5%.
As of Sept. 30, 2016, NOC had approximately $2.7 billion total liquidity consisting of $1.1 billion in cash and full availability under its $1.6 billion revolving credit facility. The company maintained significantly higher liquidity during the past five years to mitigate increased uncertainties in U.S. DoD spending. NOC's liquidity has decreased due to increased share repurchases. Approximately $550 million of NOC's cash was held overseas at the end of 2015. Fitch expects the company's liquidity has stabilized and will remain in the range of $2.7 billion to $3.3 billion over the rating horizon.
NOC's debt structure consists of senior unsecured notes denominated in U.S. dollars. NOC does not have a significant maturity until 2018 when a total of $1.1 billion of senior unsecured notes become due. Fitch believes the company will refinance its maturities and will maintain its current leverage. Fitch anticipates a part of current offerings will be used to repay 2018 maturities.
FULL LIST OF RATING ACTIONS
Fitch currently rates NOC as follows:
--Issuer Default Rating (IDR) 'BBB+';
--Senior unsecured debt 'BBB+';
--Newly offered Senior unsecured debt 'BBB+(EXP)';
--Bank facilities 'BBB+'.
Fitch currently rates NGSC as follows:
--Senior unsecured debt 'BBB+'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Sept. 30, 2016
Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.
Additional information is available at www.fitchratings.com
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016)
Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third-party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.