Fitch Affirms Airbus at 'A-'; Outlook Stable
The ratings reflect Airbus's strong position in the large commercial aircraft (LCA) market, a large order backlog, and a robust liquidity profile. Profitability and cash flow are weak for the ratings, reflecting the costs associated with the introduction of new aircraft, high unit cost of early deliveries, and problems with the company's A400M military transport aircraft. We expect profitability to improve from 2017, driven by production rate increases and cost improvement in new programmes.
Through the cycle, we expect Fitch-calculated funds from operations (FFO) and free cash flow (FCF) margins of at least 9% and 3%, respectively, for Airbus. Although Fitch believes that these margins are achievable over the coming three-to-four years failure to demonstrate positive momentum on these two ratios may place pressure on the ratings.
KEY RATING DRIVERS
Backlog Supports Revenue: Airbus has a strong business profile as one of only two large commercial aircraft manufacturers, alongside The Boeing Company (Boeing; A/Stable). Although potential competitors are entering parts of the market, Fitch does not expect them to encroach on the established manufacturers' competitive position in the short - to medium-term.
The company had firm orders of almost 6,700 aircraft representing over nine years of production, providing significant visibility of production rates and revenue despite potential volatility in orders.
Cash Flow Improvement Expected: Airbus's 2016 FFO margin of 5% is below our expectations, with key programmes diluting profitability significantly. We expect cash flow generation to begin to improve in 2017 as the A350 programme shrinks early delivery losses, though A400M problems continue to weigh on performance. We expect increasing delivery rates and cost improvement to boost cash generation from 2017, and forecast FFO margin to reach 11% by 2019.
Negative FCF for 2017: Fitch expects FCF to be slightly negative in 2017 as the company is likely to see a rise in inventory levels related to the A350 and A320neo programmes, and as underlying cash flow improvements are offset by the costs of resolving A400M shortcomings. We also expect capex to decline after 2017 as product development decreases, moving towards 3.5% of revenue in 2019 from 4.6% in 2016. To maintain the 'A-' rating, Fitch expects Airbus to demonstrate the ability to generate FCF margin of over 3% on a sustained basis.
Programme Execution Key: Airbus is in a period where key programmes cause significant movements in cash generation, with early programmes typically impacted by final development and ramp-up costs, inventory build-up burden on working capital, customer acceptance issues, and high initial recurring costs. We factor is some delays and overruns, but should Airbus face problems in key programmes, we may revise down our expectations of improvements in cash generation and take negative rating action.
A350 production ramp-up is progressing well, but an improvement in cash generation will be dependent on expeditious reductions in recurring costs. Given the maturity of the A320 programme we do not expect the transition to the A320neo to have as large an impact on group's cash generation as the A350 and A400M programmes from which we expect major recurring cost improvements and fixed cost absorption, respectively.
A400M Problems Persist: Airbus's new military transport aircraft continues to be a major cash drain. The aircraft are being delivered to customers, but do not currently deliver the capabilities contractually required, resulting in further spending to bring the planes up to specification, financial penalties payable to customers, payment retention by customers relating to deliveries already made until problems are resolved, and industrial focus on delivery of capabilities rather than recurring cost reduction that would normally be at this point in the programme.
Bombardier Partnership Has No Rating Effect: Airbus' partnership with Bombardier relating to the CSeries programme is unlikely to have a rating impact in the short - to medium-term. Airbus will not pay any cash in exchange for a 50.01% stake in the programme but will commit to providing sales, marketing, procurement and customer sale support and assemble the aircraft at its facility in the US. Upside for Airbus is possible in the long term if the programme can win extensive new orders.
Asset Sales Focus Portfolio: Significant growth in the civil business at a time of flat government defence budgets has resulted in the defence segments representing a smaller proportion of the business. Recent asset sales will lead to a focus on the group's core civil aerospace competency. Cash receipts will provide additional liquidity during the cash absorption period of new programmes and resolution of A400M issues, though once these are resolved we expect a portion of the sale proceeds to be distributed to shareholders.
Currency Mismatch: Airbus maintains a large hedging portfolio as it derives a significant portion of its revenue in US dollars rather than in its chief cost currency of the euro. This exposes it to some earnings volatility as hedges run off and are renewed. The extent of this currency mismatch remains a rating risk, although it has been gradually falling as a result of new programmes being structured in more currency-balanced ways.
Airbus has an immediate peer in Boeing. Despite a convergence of the ratings in recent years, a number of key aspects still separate the two companies' rating profiles and are likely to continue to act as important differentiating factors.
The most important of these is FCF, which at Boeing has been consistently higher over the past decade, owing chiefly to the company's better programme implementation and lower investment needs, and despite higher dividend distribution. Fitch expects Airbus's FCF to improve significantly in the coming two to three years, but it is still unlikely to exceed that of Boeing in that period.
Boeing also has a slightly better business profile than Airbus, largely as a consequence of its more diverse revenue split between commercial and defence activities. On other key business variables such as size, market position and geographic and customer diversification, both companies are equally strong and comfortably situated within the 'A' category.
Both companies exhibit strong capital structures for the 'A' category. Leverage, both gross and net, has been fairly stable in recent years and is not a key differentiating factor between the two or a significant rating driver. Likewise, liquidity, which is robust at both companies, is also strong. High cash and cash-equivalent balances have been a regular feature of both companies' capital structures and underpin the companies' ratings.
Fitch believes that, provided there is no deviation in their respective financial profiles, both Boeing and Airbus are likely to remain among the highest rated entities in the sector by virtue of their strong market positions, scale and technological leadership.
No country-ceiling, parent/subsidiary or operating environment aspects impact the ratings.
Fitch's key assumptions within our rating case for the issuer include:
- Largely flat revenue in 2017 as A380 delivery reductions and reduced defence & space business offset A350 and A320 ramp-ups. Revenue growth of around 6% in 2018 as a result of continued A350 and A320 volume growth;
- FFO margin increasing to around 11% by 2019 as a result of reduction in A350 recurring cost, A320 volume increase, and improvement in pricing as a result of transition to A320neo and A330neo variants;
- Capex falling to around EUR2.8 billion in 2017, before stabilising at around 3.5% of sales as development burden reduces;
- EUR1 billion net cash costs over 2017-2019 to resolve A400M capability and quality issues. No new material A400M charges; and
- Sharp increase in dividend payments from 2019 as FCF improves.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
-FFO margin sustainably below 9%;
-FCF margin consistently below 3% (2016: 0.7%);
-FFO-adjusted leverage sustained above 2x (2016: 3.2x); and
-Delays or material unforeseen charges relating to large programmes.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
-FFO margin sustainably above 11%;
-FCF margin consistently above 6%;
-FFO-adjusted net cash position (adjusted for negative working capital); and
-Significant improvement in Airbus's currency mismatch position.