Fitch Ratings has downgraded the long-term ratings for the Boeing Company (BA) and Boeing Capital Corporation (BCC) to 'BBB' from 'A-' and removed the ratings from Rating Watch Negative. The actions reflect the rapid escalation of the coronavirus pandemic and the effect it is having on Boeing's aviation markets and operations. Fitch has also affirmed BA's short-term ratings at 'F2'. The Rating Outlook is Negative.
Fitch's rating case includes expectations for a significant global economic downturn through the second quarter of 2020, followed by a recovery in the second half of the year and into 2021. This scenario will dramatically affect airline traffic and financial results, driving requests for delivery deferrals and lower maintenance expenditures. Under this scenario, Fitch does not expect Boeing will rebuild its credit metrics, already weakened by the 737 MAX grounding, to levels consistent with an 'A' category rating by the end of 2021, resulting in the downgrade to 'BBB'.
The Negative Rating Outlook is driven by the risk of a more extended coronavirus pandemic, the ongoing risks related to the timing of the return-to-commercial service (RTCS) of the 737 MAX, and the pace of the 737 MAX delivery ramp up after the grounding is lifted. In the case of a prolonged coronavirus impact, including extended shut-downs of Boeing's key facilities, or material delays on the 737 MAX RTCS, Fitch's expects Boeing could need access to additional capital to bridge liquidity needs until the economy recovers, which could further pressure BA's credit profile.
Factors related to coronavirus, including the duration and severity of the pandemic, will remain key concerns for BA's ratings. These factors include the continued impact on Boeing's commercial services business from lower airline traffic; the potential for increased requests for commercial airplane delivery deferrals, particularly for wide-body models; the ramifications for global GDP, which is a key driver of air traffic trends; and the direct impact on Boeing's operations, particularly in the Seattle area. Another key concern remains whether the 737 MAX grounding is lifted by mid-year.
The ratings are supported by the competitive positions of Boeing's businesses. In addition, the ratings incorporate expectations that BA has the potential to strengthen its credit profile via cash generation and debt reduction in the years after 737 MAX deliveries resume and after the coronavirus pandemic recedes. Overall, BA had a strong credit profile for its rating before the MAX grounding, and Fitch's ratings for the company incorporated the periodic stress periods that arise in the commercial aviation sector. However, the coronavirus is unprecedented in its rapid impact on the aviation sector. Fitch's forecasts include conservatism for potentially higher cost related to the 737 MAX situation. Fitch believes the lack of material 737 MAX cancelations since the grounding illustrates the aviation industry's continued support for the aircraft, which also supports the rating. Total company order backlog at the end of 2019 was $463 billion.
In addition to the pandemic and the 737 MAX, the company has a challenging agenda, including the Embraer S.A. (ERJ, BBB-/Rating Watch Negative) transaction, 777X development, and other new product development.
Boeing's debt nearly doubled in 2019 to around $27.0 billion as a result of $10.5 billion of long-term debt issuance and several billion dollars of CP issuance. Debt will continue to rise in 2020, potentially peaking at around $45 billion. Starting in 2021, Fitch expects Boeing will pay down debt and reduce much of its CP balance.
KEY RATING DRIVERS
The coronavirus pandemic has added another significant challenge to Boeing's already crowded agenda. To date the global airline industry has seen air traffic severely affected. This was first noted in China and the broader Asia-Pacific region, the aviation sector's fastest growing area, although there are some indications that a recovery in Chinese aviation has begun. All of other regions have now seen the coronavirus impact. Globally, the virus' impact on aviation could worsen depending on the pandemic's duration and severity.
Coronavirus risks for Boeing are both global and local. From a global perspective, Fitch has several virus related concerns related to Boeing's financial performance. First, lower air traffic will hurt results at Boeing Global Services (BGS) due to lower aftermarket services and parts; Fitch estimates some parts of BGS could see revenues down mid-teens in 2020. The segment's results would be further affected if the pandemic serves as a catalyst for an extended global recession. The pandemic has also spurred airline delivery deferral requests, and aircraft deliveries will be lower than previously expected in both 2020 and 2021. This is a key driver of Fitch's forecast revisions and the rating downgrade. Fitch believes wide-body demand has taken the biggest hit, but the situation could also lead to a slower 737 MAX production ramp up.
Locally, coronavirus will affect Boeing's operations, particularly in the Seattle area, which the virus has hit harder than most other regions in the U.S. Approximately 45% of Boeing' employees are in Washington State, where the governor has directed residents to stay at home. The company announced a temporary shut-down of Seattle area operations for two weeks. Several employees at its Everett facility, where most of the company's twin-aisle aircraft are assembled, have contracted coronavirus. A negative scenario, in Fitch's view, would be if operations at the Everett facility or other key facilities nation-wide had to be slowed or shut for several months.
Commercial Aircraft Deliveries:
Fitch expects aircraft deliveries will be lower than previously expected in both 2020 and 2021, which is a key driver of the rating downgrade. Fitch believes wide-body demand has taken the biggest hit, but the situation could also lead to a slower MAX production ramp up.
Fitch's forecasts are informed by the firm's credit review of the global airline industry last week, as well as insights from Fitch's aircraft leasing and aircraft ABS teams. The global airline review incorporated scenarios where capacity or revenues fall 75% to 100% for many airlines in the second quarter of 2020 before recovering in the second half. The review resulted in negative rating actions across the board, mostly Negative Outlooks. Delivery deferrals are key elements of most airlines' near-term plans to address the severe liquidity pressures caused by the pandemic. Fitch believes some of the deferrals will be into the second half of 2020, but some will flow into 2021. After the recovery begins, airlines in general will have higher debt levels and lower liquidity than pre-pandemic, which will drive additional delivery deferrals in 2021.
The wide-body aircraft market will be most affected, in Fitch's view, given the severe impact on long-haul routes. Deliveries in 2021 could fall one-third or more. Cargo aircraft could see less pressure than passenger jets. Overbooking will relieve some of the delivery pressure on the 737 MAX, but Fitch expects the production ramp up will slow versus prior expectations.
Other risks to the delivery outlook include supply chain disruptions and the aircraft finance market. Fitch has included no material customer financing from Boeing in its forecasts, but it would be negative for Boeing's credit profile if the company does need to meet some of its financing commitments due to disruption in the capital markets. Fitch expects the U.S. Export-Import Bank will ease some of the pressure in the market and could see a significant amount of activity in the next two years.
737 MAX Grounding:
A key rating concern continues to be regulatory risk and uncertainty regarding the timing and global sequencing of the 737 MAX' RTCS. On Jan. 21, Boeing issued a statement that it now expects the ungrounding will begin in mid-2020. It is unclear how the coronavirus affects the MAX timeline, but Fitch believes the pandemic increases the risk that this date could be pushed back. The MAX will likely be a concern throughout the aviation credit sector through 2021 as the airline industry catches up on delayed MAX deliveries. The MAX situation reduced much of Boeing's financial cushion in the 'A' category, leaving the company more exposed to other unforeseen events or industry developments, such as the coronavirus.
The logistical challenge of returning the planes to service and catching up on deliveries is also a concern, particularly considering the risk of supplier challenges with an extended 737 MAX production suspension. BA's substantial debt build-up over the past 12 months is another concern. There is also uncertainty over the ultimate amount of concessions BA will make to airlines. The MAX situation is also likely to increase business risk from fines, litigation, weakened competitive position, or reputation damage. Fitch also expects there will be a lingering operating margin impact for several years even after the MAX returns to commercial service.
Fitch views the MAX situation as partly an issue of timing unless substantial orders are cancelled. However, key uncertainties remain in addition to the unclear timing on RTCS. These include pilot training requirements, public perception of the MAX, negotiations with Boeing's customers over concessions, MAX valuations, aircraft finance impact, and lawsuits/investigations. There is also uncertainty surrounding the phasing of RTCS throughout the world. It is also clear that the role of regulators in the airplane certification process will change. Upcoming watch items include the FAA certification test flight and first quarter earnings.
Potential Capital Needs and Potential Government Support:
BA's decision to suspend its dividend was a form of self-help that will reduce cash outflows by approximately $9 billion over the next two years. However, in the scenario of a prolonged coronavirus impact, including extended shut-downs of Boeing's key facilities, or material delays on the 737 MAX RTCS, Boeing could still need access to additional capital to bridge liquidity until the economy recovers or MAX deliveries resume. Additional debt beyond current expectations could pressure the 'BBB' ratings.
Fitch has general concerns regarding continued comments about the possibility of government support, but broad government support for the aerospace sector is not incorporated into Fitch's analysis. Debate about various proposals continues in Washington. Fitch believes Boeing and its suppliers would require government support in the scenario of an extended pandemic combined with significant disruption of the public capital markets. However, the announcement of the new Federal Reserve programs yesterday lessened some concerns. Support for airlines worldwide by various governments would indirectly support the aerospace sector.
The downgrade and Negative Outlook revision of BCC's ratings and reflect the linkage with that of its parent, BA, and the fact 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, BCC's role arranging, structuring, and providing financing to support for 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 'BBB' 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 operating income declined in 2019 due to lower gains on the sale of assets and the recognition of modest impairments, driven by one customer. Asset quality as deteriorated slightly in recent years as the decline in the total receivable portfolio has outpaced the reduction in assets placed on non-accrual status. However, Fitch believes that current loss reserves provide adequate support relative to potential losses on receivables.
ESG: BA has an ESG relevance score of '4' for Management and Strategy due to 737 MAX challenges, which has had a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors. Below average execution on the 737 MAX strategy has contributed to higher costs and potential reputational damage.
Boeing's most immediate peer is Airbus SE (A-/F1/Positive). Several key credit factors differentiate the two companies' ratings. Cash flow generation is one of the key differentiators between Airbus and Boeing. Boeing consistently achieved better FCF and FFO over the past decade, due to better program execution and lower investment needs despite higher dividend payments. However, the 737 MAX grounding has severely affected Boeing's cash flow, and caused debt to rise significantly versus Airbus. Boeing's business profile has also been modestly stronger than Airbus' because of a more diverse revenue mix between commercial and defense. Airbus currently has a stronger balance sheet and liquidity position. Airbus generally operates with a higher net cash position than Boeing, and this has been widened by the 737 MAX situation at Boeing. FX exposure is a key differentiator between Boeing and Airbus, with the former having little exposure and the latter have significant exposure, although Airbus has taken actions to lessen the situation.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
--The 737 MAX groundings will be lifted in phases by different regions through 3Q20. Deliveries in various regions will resume in 2020 shortly after the groundings are lifted;
--Total MAX inventory build will exceed $15 billion;
--The 737 MAX program order backlog does not suffer material cancelations;
--BA moves the 737 production rate up at a slower than expected rate due to the impact of the coronavirus on the airline industry;
--The inventory of MAX aircraft assembled but undelivered during the grounding will be delivered in 2020 and 2021;
--Margins are negatively affected by MAX-related costs in 2019 through 2021, but remain consistent with the rating in 2021, with EBIT margin approximately 10%;
--Concessions and other considerations for 737 MAX customers affected by the grounding will rise from the $8.8 billion amount already estimated and recognized by Boeing;
--The Boeing-Embraer commercial JV closes in the second half of 2020. Boeing finances its $4.2 billion payment to Embraer with cash and also consolidates approximately $3.5 billion of Embraer debt and a similar amount of cash;
--Debt rises in 2020, then for several years Boeing pays down debt and reduces much of its CP balance;
--Share repurchases remain suspended through the forecast period;
--The dividend suspension remains in effect through 2021 and part of 2022;
-- Additional cuts to the 787 and other wide-body models due to the impact of the coronavirus pandemic; The 787 production rate is already scheduled to be reduced to 12 per month from 14 per month in late 2020 and then to 10 per month in early 2021;
--The 777X enters service in 2021.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Extended coronavirus pandemic leads to more delivery deferrals of Boeing airplanes or material declines in revenues at BGS;
--Coronavirus causes material disruptions to Boeing's operations, including extended shut-downs of key facilities;
--Substantial order cancellations and related material cost increases for the 737 MAX program;
--Material delays in resuming 737 MAX deliveries in a phased manner beyond the mid-year 2020 time frame;
--Indications of materially higher business risk from regulatory challenges, fines, litigation, or reputation and brand damage from the 737 MAX situation;
--Material negative developments with any of the company's other major programs leading to delivery delays, order cancellations, large additional costs or inventory write-downs;
--Large acquisitions, particularly combined with a sector downturn, or debt-funded share repurchases;
--Sustained consolidated FFO-adjusted leverage above 3.0x to 3.5x;
--Sustained FCF margins below 3%.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
--The Rating Outlook could be revised to Stable if Fitch gains confidence the severity and duration of the coronavirus pandemic will not materially affect Boeing's credit profile;
--Positive rating actions could be considered if the company returns the 737 MAX program to a stable condition and begins to reduce debt taken on to fund inventory build related to the 737 MAX program.
BCC's ratings and Rating Outlook Negative are linked to those of its parent. The revision of BCC's Rating Outlook will 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. Negative rating actions could be driven by a downgrade of BA's ratings or the early termination of the parent guarantee prior to the repayment of BCC's outstanding publicly issued debt.
LIQUIDITY AND DEBT STRUCTURE
Boeing had a consolidated liquidity position of approximately $13.5 billion as of YE 2019, consisting of $10.0 billion in cash and investments and $9.6 billion of revolving credit facility availability, offset by $6.1 billion of outstanding CP.
On Oct. 30, 2019, the company refinanced and increased its revolving commitments to $9.6 billion, including a $3.2 billion 364-day revolver, a $3.2 billion three-year revolver, and a $3.2 billion five-year revolver. The new $9.6 billion of revolving commitments back the CP program of the same size.
In early 2020, the company entered into a two-year Delayed Draw Term Loan with a group of banks to cover cash needs during 2020. The amount was $13.8 billion. The company decided to draw down the facility early in response to the coronavirus pandemic.
Consolidated debt, as of Dec. 31, 2019, was $27.3 billion ($25.3 billion attributable to BA, and $2.0 billion attributable to BCC), of which $7.3 billion was classified as short-term, including $6.1 billion of CP. Most of the debt attributable to BCC consists of intercompany loans from BA to BCC; the last significant amount of debt originally issued by BCC and subsequently guaranteed by BA matured in October.
Boeing's cash generation typically contributes to its liquidity position. The company generated $9.6 billion of FCF in 2018, but 2019 FCF was substantially negative ($8.9 billion) due to working capital build up related to the 737MAX. Fitch expects long term annual free cash will be at least at 2018 levels, or greater than $9 billion per year, but Fitch expects FCF in 2020 will again be significantly negative as the company recovers from the MAX grounding. In 2021, FCF will be enhanced by the run-off of MAX inventories.
Fitch does not expect Boeing to make material pension contributions in the next few years. Boeing made $4.0 billion of discretionary pension contributions in 2017, including a $3.5 billion contribution in the form of company shares. This satisfied most required contributions for the next several years. Boeing's GAAP pension deficit at the end of 2019 was $15.9 billion.
BCC Treatment: 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 Boeing, we do not follow this process but instead look at financial metrics primarily on a consolidated basis. Fitch looks at Boeing and BCC on a consolidated basis for several reasons. BCC evolved into a less significant part of Boeing's financials as a result of the successful strategic shift to reduce BCC's emphasis on portfolio growth and increase focus on facilitating third-party financing for customers. BCC's primary strategic mission is not regular lending to Boeing's customers, but only occasionally financing aircraft, with approximately 99% of the company's deliveries typically financed by third parties.
The financial information Fitch has for BCC is not as detailed as is typically the case with industrial finance captives. In early 2013, Boeing fully guaranteed all of BCC's outstanding debt, which is also not typical of the industrial finance captives rated by Fitch. BCC stopped making separate SEC filings. In general, Fitch's approach of consolidating BCC's financial statements is a more conservative approach to the credit analysis of Boeing than if BCC were consolidated.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
BCC's ratings and Rating Watch are linked to those of its parent, The Boeing Company.
BA has an ESG relevance score of '4' for Management and Strategy due to 737 MAX challenges, which has had a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors. Below average execution on the 737 MAX strategy has contributed to higher costs and potential reputational damage.