Fitch Ratings-New York-17 May 2018: Fitch Ratings has affirmed The Boeing Company's (BA) Long-term Issuer Default Rating (IDR) at 'A' and Short-term IDR at 'F1'. Fitch has also affirmed Boeing Capital Corporation's (BCC) Long-term IDR at 'A'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
The ratings cover approximately $12.5 billion of debt ($10 billion attributable to BA and $2.5 billion attributable to BCC), up from about $10 billion at the end of 2016. Of the amount attributable to BCC, Fitch estimates that approximately $775 million consists of debt originally issued by BCC and subsequently guaranteed by BA, with the remainder consisting of intercompany loans from BA to BCC. BA ended 2017 in a net debt position ($1.1 billion) for the first time in six years, and Fitch expects debt levels will rise again in 2018.
KEY RATING DRIVERS
BA's ratings reflect its strategic positions in the commercial aerospace and defense sectors, high barriers to entry in its key businesses, strong liquidity position, cash generation, and large backlog ($486 billion). The ratings are also supported by the company's demonstrated ability to withstand challenging periods such as the post-9/11 downturn, the most recent economic recession, and the 787/747-8 development delays. Financial flexibility is another rating strength.
BA has earned credit for lowering its risk profile by shifting a substantial number of employees to defined contribution benefit plans, signing long-term labor agreements, and successfully executing a significant number of aircraft production rate changes over the past several years.
Concerns include M&A activity; the potential for delays and cost overruns on development programs; regular and substantial charges; the aging of parts of Boeing's defense portfolio; some remaining uncertainty about the ultimate profitability of the 787 program; the size of the company's pension deficit on a GAAP basis ($16.4 billion); and the susceptibility of the commercial aerospace industry to shocks such as terrorism and disease.
Margin levels remain low for the rating category, but BA has made progress addressing this in the past two years. Also, the company's portfolio is less balanced than it once was, as commercial growth has reduced the weight of defense revenues as a percentage of consolidated revenues. Growth of the company's services offerings could improve BA's balance, diversification, and margins. The intense competitiveness of the commercial airplane industry is also a rating consideration.
M&A Credit Risks
Credit risks from M&A activity have been rising as a result of potential strategic transactions, as illustrated by the pending KLX acquisition and BA's ongoing discussions with Embraer S.A. (ERJ, BBB-/Stable). These M&A risks are mitigated by BA's substantial cash generation (estimated post-dividend FCF of $8.0-9 billion annually), sizable liquidity position, and low leverage for the current rating. Fitch calculates BA's current leverage (adjusted debt to EBITDAR) at approximately 1.0x, at least a half turn below the mid-point for 'A' category aerospace & defense companies. At the current ratings, Fitch believes BA has several billion dollars of excess liquidity, and it also has several billion dollars of debt capacity.
Boeing's (BA) $4.25 billion acquisition of KLX Aerospace Solutions Group (KLX) will not by itself affect Fitch's ratings covering BA. BA intends to fund the transaction will cash on hand ($9.9 billion at the end of March), supplemented by debt if needed. Fitch believes debt would be temporarily issued commercial paper. BA expects to close the transaction in the third quarter, with closing contingent on the spin-off of KLX's Energy Services Group, as well as regulatory approval and KLX shareholder approval. Fitch's concerns with the transaction include valuation (more than 14x projected 2018 EBITDA) and integration risks.
A key question looking forward will be whether BA pursues additional cash-funded acquisitions. An additional transaction equal in size to KLX or larger would likely require permanent debt funding. This would use up much of BA's debt capacity at the current rating, and could possibly lead to a review of the BA's ratings or outlook depending on the size of the transaction. The company's credit profile could also be at greater risk in a downside scenario.
Share Repurchases and Dividends
Fitch assumes BA will continue to allocate almost all of its FCF to dividends and share repurchases, and M&A would be funded with incremental debt or cash on hand. Key assumptions underlying this analysis include continued healthy cash generation and a willingness to reduce or eliminate share repurchases when stress arises, as Boeing has done several times over the past 15 years. Substantial shareholder-focused deployment continues, with a new $18 billion share repurchase program and a 20% dividend increase. Significant shareholder cash deployment is not a ratings threat at this point, but it is slowing BA's improvement in its credit profile.
Boeing Global Services and Vertical Integration
BA's goals of growing services revenues and increasing the degree of vertical integration in targeted areas are some factors driving the company's acquisition appetite. Boeing's third major operating segment, Boeing Global Services (BGS), started operations on July 1, 2017, with a focus on services and support in both commercial aviation and defense. Boeing's $50 billion revenue target for the segment is a substantial increase from BGS' 2017 revenues of $14.6 billion. Some growth should come from the expected market increases in both commercial and defense, but Fitch expects BA will have to either take market share from other players or buy businesses to reach its target.
Fitch views this new segment as a key development that could drive growth and margin improvement. Fitch believes the greater emphasis on life-cycle services could affect some elements of BA's business model, including decisions to launch new programs. Potentially greater services revenues through the life of a program could make some proposed programs more economically viable than if evaluated only on an original equipment basis.
Ongoing Discussions with Embraer
Boeing and Embraer have been in talks over a potential combination for at least five months. The future of ERJ's Defense & Security operations appears to be a significant issue, mainly on national security grounds, and recent comments by ERJ indicate the transaction may not be an outright purchase of ERJ by BA, but instead a commercial aerospace combination excluding ERJ's Defense & Security segment and possibly ERJ's business jet operations. The Brazilian government owns a "golden share" in ERJ, as well as direct and indirect shareholdings, so it is playing a significant role in the negotiations.
If an agreement is reached, the transaction's structure and price would be the main credit drivers for both companies. Although a transaction could positively affect ERJ's credit profile, potential outcomes cover the credit spectrum depending on the transaction's structure, so Fitch would be able to evaluate the ratings impact only after seeing the terms if a transaction were to occur. Fitch believes BA's credit rating would not likely be affected given ERJ's enterprise value.
Combining with ERJ would broaden BA's commercial portfolio to the lower end of the narrowbody commercial aircraft market and the regional jet market with ERJ's E2 family. There would be little or no overlap with BA's existing portfolio, and a combination would provide a strategic answer to Airbus' planned takeover of Bombardier's CSeries program. Another benefit would be consistency with Boeing's strategic initiatives in services and vertical integration. Boeing could also gain access to ERJ's highly-regarded work force, including engineering talent.
Commercial Airplane Outlook
The Large Commercial Aircraft (LCA) market continues to be in an upturn, and Boeing Commercial Airplanes (BCA) is currently experiencing a near record operating environment in terms of deliveries, orders, and backlog. The large order book (5,904 aircraft at the end of April 2018), overbooked delivery slots, and geographic diversity support the outlook for continued modest growth over the next several years. Fitch's forecast for Boeing's deliveries is 820 aircraft in 2018 and 890 aircraft in 2019. Key indicators of aircraft demand such as global airline traffic remain positive.
Fitch considers all of BA's programs healthy, with the exception of the 747 program. BA is raising production rates on all models except the 777 and 747, and Fitch expects higher 777 rates once the 777X enters the market. Key questions for BCA over the next year will be whether it raises 737 rates further, whether the supply chain can support additional rate hikes, and whether BA will launch the "New Mid-market Airplane" (NMA). Fitch believes there is demand for the NMA, but questions remain about the price. It is not clear whether a business case can be made for the NMA given high development costs, although new production systems and services offerings could change the calculation, even with the likely investment required in vertical integration.
Boeing and the commercial aerospace sector face rising trade risks. This has been a concern since the 2016 election, but the recent tariff threats have made it a near-term priority. Boeing is the U.S.'s largest exporter, and aircraft are the biggest U.S. export category to China. Revised trade policies could affect BA's competitive position, but there are several potential mitigating factors. The practicalities of aircraft manufacturing and airline operations would limit the immediate impact of tariffs, as airlines would find it difficult and costly to shift quickly from Boeing aircraft to Airbus planes. The largest risk from a potential trade dispute is that it evolves into a trade war that produces a global recession, potentially ending the long commercial aviation upturn.
The rating affirmation for BCC primarily reflects that BA has provided unconditional guarantees for the due and punctual payment and performance of all of BCC's outstanding publicly-issued debt. In addition to the guarantee, BCC's role arranging, structuring, and providing financing to support the sale of BA's products, the high level of management and operational integration between the two entities, BA's track record of support for BCC, and the fungibility of funding between the two entities further support Fitch's view of BCC as a core subsidiary of BA. Consistent with Fitch's 'Non-Bank Financial Institutions Rating Criteria', the ratings of core subsidiaries are equalized with those of its parent.
BCC has historically exhibited sound operating performance, stable asset quality, and a sufficient liquidity profile, although its standalone credit risk profile would likely be lower than 'A' given the cyclicality and residual value risk associated with the aircraft leasing business, the credit risk profile and concentration of BCC's lessors and its elevated leverage levels relative to standalone aircraft lessors.
BCC's revenues and operating income have remained relatively flat, driven by portfolio run-off and aircraft sales, offset by modest new origination activity. Asset quality has also remained relatively stable over the years, as the company has worked through a number of credit issues within its portfolio and reduced overall risk resulting from a decrease in customer financing. Fitch believes that current loss reserves, the current supportive aircraft financing environment, and improved airline credit fundamentals, provide adequate support relative to potential losses on receivables.
In most cases where an industrial company has a captive finance subsidiary Fitch deconsolidates the subsidiary and then evaluates the parent's financial statements treating the subsidiary as an equity investment. In the case of BA, Fitch does not follow this process but instead looks at financial metrics primarily on a consolidated basis.
Fitch looks at BA and BCC on a consolidated basis for several reasons. BCC has evolved into a less significant part of BA's financials as a result of the successful strategic shift to reduce BCC's emphasis on portfolio growth and increase its focus on facilitating third-party financing for its customers. BCC's primary strategic mission is not regular lending to BA's customers but only occasionally financing aircraft, with approximately 99% of BA's deliveries typically financed by third parties.
The financial information Fitch has about BCC is not as detailed as is typically the case with industrial finance captives. In early 2013 BA fully guaranteed all of BCC's outstanding debt, which is also not typical of the industrial finance captives rated by Fitch. In general, Fitch views consolidating BCC's financial statements to be a more conservative approach to the credit analysis of BA than if the firm were to deconsolidate BCC.
Boeing's most immediate peer is Airbus (A-/Stable). Despite some convergence in credit profiles over the past several years, several key credit factors still differentiate the two companies' ratings. Cash flow generation is one of the key differentiators between Airbus and Boeing. Boeing has consistently achieved better FCF and FFO over the past decade, due to better program execution and lower investment needs despite higher dividend payments. Cash generation should continue to grow at both companies, but Boeing's cash flow advantage is likely to persist. Boeing's business profile is also modestly stronger than Airbus' because of a more diverse revenue mix between commercial and defense. Both companies have strong balance sheets and liquidity positions, with Airbus generally operating with a higher net cash position than Boeing.
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
--Large commercial aircraft deliveries of approximately 820 aircraft in 2018 and 890 in 2019;
--Commercial aircraft revenue increases in 2018 due to higher 737 production volume, while BDS and BGS revenues also rise;
--EBITDA Margins expand modestly through the rating horizon;
--Boeing refinances all debt maturities in addition to some incremental debt issuance;
--The $4.25 billion KLX acquisition closes in the second half of 2018 and is funded mainly with cash;
--Other substantial M&A transactions, including a potential combination with Embraer, are not included in our assumptions. The credit impact of other M&A transactions would depend on the form of financing;
--Substantial share repurchases and dividend increases;
--Share repurchases will be suspended in the event of liquidity pressures or an industry shock.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
Positive rating actions could be driven by an improvement in BA's credit profile from higher commercial aircraft deliveries, debt reduction and pension contributions. BA's margins are in some respects low for the rating category, so several initiatives to boost margins, if successful, could also drive positive rating actions. Modifying the cash deployment strategy to have less focus on share repurchases could also lead to positive ratings actions.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
There could be a negative rating action if there are material negative developments with any of the company's major programs leading to delivery delays, order cancellations, large additional costs or inventory write-downs. Large acquisitions, particularly combined with a sector downturn, also could affect the ratings, as could debt-funded share repurchases. Sustained consolidated FFO-adjusted leverage above 2.0x and a substantial deterioration in FCF could lead to a negative action.
BCC's ratings and Rating Outlook are linked to those of its parent. Positive rating actions would be limited to Fitch's view of BA's credit profile. Fitch cannot envisage a scenario where the captive would be rated higher than its parent. Conversely, negative rating actions could be driven by a change in BA's ratings or from a change in the perceived relationship between BCC and BA, including the early termination of the parent guarantee prior to the repayment of BCC's outstanding publicly issued debt.
As of March 31, 2018, Boeing had a strong consolidated liquidity position of approximately $14.3 billion consisting of $9.9 billion in cash and investments and $4.4 billion of revolving credit facility availability. The company has $5 billion of committed credit facilities consisting of a $2.5 billion 364-day facility expiring in October 2018 and a $2.5 billion facility expiring in November 2022. BA recently increased the size of its commercial paper programs to match the size of the credit facilities.
BA's strong cash generation contributes to its liquidity position. The company generated $8.2 billion in free cash flow in 2017, and Fitch expects the company's average annual free cash flow over the next three years will be at least at the 2017 level.
Consolidated debt at the end of March was $12.5 billion of which $1,981 million is classified as short-term, including $600 million of commercial paper. During 2017, the company issued $900 million in unsecured notes, and during the first quarter of 2018 it issued an additional $1.4 billion. Annual debt maturities average approximately $1.25 billion through 2020.
Boeing made $4 billion of discretionary pension contributions in 2017, including a $3.5 billion contribution in the form of Boeing shares. This satisfied most required contributions for the next four years, and Fitch does not expect BA to make pension contributions through its projection period.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
The Boeing Company
--Long-Term IDR at 'A';
--Senior unsecured revolving credit facility at 'A';
--Senior unsecured notes at 'A';
--Short-Term IDR at 'F1';
--Commercial Paper at 'F1'.
Boeing Capital Corporation
--Long-Term IDR at 'A';
--Senior unsecured notes at 'A'.
The Rating Outlook is Stable.