NEW YORK, NY – Fitch Ratings has affirmed The Boeing Company’s (BA) ‘A’ Long-Term Issuer Default Rating (IDR) and ‘F1’ Short-Term IDR. Fitch has also affirmed the ‘A’ Long-Term IDR for Boeing Capital Corporation (BCC). A full list of ratings is included at the end of this release.
The Rating Outlook is Stable. The ratings cover approximately $10 billion of debt ($7.6 billion attributable to BA and $2.4 billion attributable to BCC), up from about $9 billion a year ago. Of the amount attributable to BCC, Fitch estimates that approximately $1.3 billion consists of debt originally issued by BCC and subsequently guaranteed by BA, with the remainder consisting of intercompany loans from BA to BCC.
KEY RATING DRIVERS
Boeing’s ratings reflect its competitive position in the commercial aerospace and defense sectors, financial flexibility, liquidity position, access to capital markets, high barriers to entry in its key businesses, and large backlog ($480 billion). The ratings are also supported by the company’s demonstrated ability to withstand very challenging periods such as the post-9/11 downturn, the most recent economic recession, and the 787/747-8 development delays.
Boeing has also earned credit for successfully lowering its risk profile by shifting a substantial number of employees to defined contribution benefit plans, successfully executing a significant number of aircraft production rate changes, and signing long-term labor agreements. Several initiatives to boost margins, if successful, could enhance the company’s credit profile.
Concerns include low margin levels for the rating category; the aging of some of Boeing’s defense programs; some remaining uncertainty about the ultimate profitability of the 787 program; the potential for delays and cost overruns on development programs; the size of the company’s pension deficit on a GAAP basis ($17.3 billion); pricing trends for some aircraft models; and the susceptibility of the commercial aerospace industry to shocks such as terrorism and disease. Also, the company’s portfolio is less balanced than it once was, as commercial growth has reduced defense revenues to less than one-third of consolidated revenues. The intense competitiveness of the commercial airplane industry is also a rating consideration.
Increasingly aggressive cash deployment to shareholders is not currently a threat to the rating, as it has generally been funded from operating cash flow. However, it has slowed the improvement in BA’s credit profile. BA’s focus on share repurchases ($12.8 billion over 2014 and 2015, with a new $14 billion program announced in December) and dividend increases (nearly doubled in the past three years) is coming at the expense of debt reductions and pension contributions. The nearly $1 billion debt increase in 2015 was not consistent with Fitch’s expectations, and the increase broke a three-year run of debt reduction. Fitch is not forecasting material M&A activity at Boeing in the next few years, but, if transactions do emerge, Fitch expects they would most likely be in the defense segment or in the services area.
Financial flexibility remains a credit positive. Boeing has a pattern of shutting off share repurchases in times of potential liquidity pressures, then resuming repurchases when the environment stabilizes. Boeing’s pension contributions are almost entirely voluntary because it is more than 100% funded on an ERISA basis.
Boeing Commercial Airplanes (BCA) is the company’s largest segment, and it continues to be the main driver of the BA’s financial performance. The commercial aerospace market is currently very healthy, and Boeing’s commercial backlog at the end of March (5,740 aircraft) reflects this strength. The backlog represents approximately 7.5 years of production at current build rates. Deliveries in 2015 rose 5% to an industry record 762 airplanes from 723 airplanes in 2014. BCA had 768 net orders in 2015, the sixth year in a row in which net orders exceeded deliveries.
Despite the strong demand environment, several transitioning programs will mean BCA’s 2016 deliveries will not match production rates. Fitch estimates this will lead to a delivery decline in 2016 to approximately 745 aircraft. The programs driving this delivery decline are the 737 MAX and the 767 Tanker, both of which are in the final stages of development and certification. Boeing will be building inventory for these programs ahead of certification and delivery in 2017. The production rate cut for the 747-8 program will also make a modest contribution to the delivery decline. Fitch does not believe the inventory build for the MAX and the 767 are material risks because of its modest size relative to the company’s liquidity position.
Fitch expects 2017 deliveries will rebound to approximately 790-800 deliveries, with deliveries likely exceeding production rates.
The 787 program remains a key driver of Boeing’s growth and competitive position. Many risks have been retired, and the company has said the program began contributing positively to cash flow in late 2015. After a difficult development process, the 787 is now well-established in the aviation market, allowing airlines to open up many new direct routes and supporting some new business models. The 787 is one of the most attractive types of collateral in the aircraft finance business. Fitch estimates the program could currently account for as much as $13-15 billion of annual revenues, with the potential to grow to nearly $20 billion by the end of the decade.
However, Fitch still has some concerns about the program’s ultimate profitability and cash generation. After delivering roughly 30% of the program accounting quantity (393 aircraft out of 1,300) the program is still operating at only near break-even gross margins, according to BA’s SEC filings. The program has accumulated $28.65 billion of deferred production costs through the first quarter of 2016, although this amount grew only modestly from the end of 2015, which is a sign the cost trend could be starting to move in the right direction.
Fitch evaluates the 787 on a forward-looking basis, and the large amount of historical costs accumulated on BA’s balance sheet is less important than the future cash generation of the program. A write-down of some deferred production costs would be unlikely to result in a ratings action unless the magnitude of the write-down indicated an inability to reach healthy cash flow in the future.
Margins and Financial Metrics
BA’s GAAP margins are low compared to similarly rated corporate credits in Fitch’s portfolio. Fitch calculates BA’s consolidated 2015 EBITDA margin at 9.9%. Adjusting for charges ($1.72 billion) and non-cash pension expense ($2.4 billion) would raise the margin to 14.1%, which would still be about two-thirds of the median for ‘A’-rated U.S. corporates in Fitch’s portfolio. Cash flow margins put BA in a more positive light, but they are still below the levels of similarly rated industrial companies.
Fitch expects margins to rise 50-75 bps in 2016 as the impact of cost reduction actions is partly offset by dilution from the 787 and 747 programs and higher R&D as several commercial programs move through development. Upside to margins could come from several initiatives (Market Based Affordability, Partnering for Success, services growth, controlling development costs, and others). The impact on the supplier base is an item to watch.
Other than the relatively low operating margins, BA’s financial metrics are strong for the ‘A’ rating. At Dec. 31, 2015 BA’s leverage (debt to EBITDA) was 1.0x, up slightly from 0.9x at the end of 2014. Fitch estimates core leverage (excluding debt attributable to BCC) was 0.8x in 2015 compared to 0.7x in 2014 and 0.8x in 2013. FFO Adjusted Leverage was also 1.0x, up from 0.7x at the end of 2014. FFO Fixed Charge Coverage was approximately 17x at the end of 2015, down from 19x in 2014. Fitch does not expect any meaningful changes in the above metrics in the next two years.
Boeing’s Defense, Space & Security segment (BDS) provides some balance to the company’s business mix, which strengthens BA’s overall credit profile. With nearly $30 billion in revenues and a $56 billion backlog, it is a large stand-alone business. The fiscal 2015 U.S. defense budget hit a trough (base budget and wartime spending), and it began rising in fiscal 2016. However, Fitch still considers the defense outlook to be somewhat uncertain, partly due to the Pentagon’s intense focus on lowering costs, including some questioning of the defense sector’s profitability.
Fitch considers BDS’ portfolio to be of mixed quality, with some solid and growing programs offset by a group of aging programs. These older programs need to be replaced with new opportunities to avoid restructuring actions at BDS later this decade, especially in areas related to fighter aircraft programs. The loss in the competition for the Long Range Strike Bomber was a disappointment in 2015. International opportunities could also help maintain BA’s overall defense position. The actions of several new players in the space launch and satellite sectors will be monitored for their impact on BA’s operations.
As of Dec. 31, 2015, Boeing had a strong consolidated liquidity position of approximately $17 billion. This consisted of $12.1 billion in cash and investments, and complete availability under $5 billion of bank facilities. The bank facilities are split into two $2.5 billion parts, one expiring in November 2016 and the other in November 2020. Consolidated debt at the end of December was $10 billion. The company has $1.2 billion of debt maturing in 2016, including $500 million at BCC.
Boeing’s FCF (cash from operations, less capex and dividends) was $4.4 billion in 2015, down slightly from $4.5 billion in 2014. Fitch expects FCF to be flat or decline slightly in 2016 and 2017 as capital expenditures and dividends remain elevated, offset partially by higher cash flow from operations.
As a result of the likely substantial share repurchases in 2016, Fitch expects BA will end the year in a net debt position. This will end a period of at least four years in which BA carried a net cash position.
Fitch views BCC as a core subsidiary of BA, reflecting its role arranging, structuring, and providing financing to support the sale of BA’s products. The rating linkages are also based on the high level of management and operational integration between the two entities, as well as BA’s track record of support for BCC, reflecting the fungibility of funding between the two entities. Consistent with Fitch’s ‘Global Non-Bank Financial Institutions Rating Criteria’, the ratings of core subsidiaries are equalized with those of its parent.
In addition, BA has provided unconditional guarantees for the due and punctual payment and performance of all of BCC’s outstanding publicly-issued debt. Fitch views the parent guarantees as the strongest form of parental support, which in Fitch’s view, further enhances the rating linkages between the parent and subsidiary. BCC’s has historically exhibited sound operating performance, stable asset quality, and 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 of BCC’s lessors and its elevated leverage levels relative to standalone aircraft lessors.
BCC’s operating performance is consistent with the company’s operating strategy focused on minimizing the use of its balance sheet in support of BA’s aircraft sales. Segment revenues and operating income has remained relatively flat driven by portfolio run-off and aircraft sales, offset by modest new origination activity. Asset quality performance 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, direct BA support, and the current supportive aircraft financing environment, as well as improved airline credit fundamentals, should provide sufficient support relative to potential losses on receivables.
Fitch’s key assumptions within the rating case for BA include:
–Large commercial aircraft deliveries 745 aircraft in 2016 and 790-800 in 2017;
–Defense revenues will be decline in 2016 and will be flat or down modestly in 2017;
–EBITDA Margins in 2016 will rise 50-75 bps;
–Refinancing of all debt maturities;
–Substantial share repurchases and dividend increases;
–Share repurchases will be suspended in the event of liquidity pressures or an industry shock.
Positive rating actions could be driven by an improvement in Boeing’s credit profile from higher commercial aircraft deliveries, debt reduction, and pension contributions. Boeing’s margins are 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.
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, although not anticipated, also could negatively affect the ratings, as could debt-funded share repurchases. Sustained consolidated FFO adjusted leverage approaching 2.0x could lead to a negative action.
BCC’s ratings and Rating Outlook are linked to those of its parent. Positive rating actions are limited by Fitch’s view of BA’s credit profile, thus 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.