OREANDA-NEWS. Fitch Ratings has affirmed Airbus Group SE's (Airbus) Long-Term Issuer Default Rating (IDR) at 'A-'. Fitch has also affirmed Airbus's and Airbus Group Finance BV's senior unsecured ratings at 'A-' and Airbus's Short-Term IDR and commercial paper rating at 'F2'. The Outlook on the Long-Term IDR is Stable.

The ratings reflect Airbus's strong position in the large commercial aircraft (LCA) market, a large order backlog, which provides good visibility on revenue, and a robust liquidity profile. Profitability and cash flow are currently weak for the rating, reflecting the costs associated with the introduction of new aircraft including development costs, inventory build-up, and high unit cost of early deliveries. We expect profitability to improve significantly 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 the company to maintain the 'A-' rating. Although Fitch believes that the company will achieve these margins 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 Revenues

Airbus has a strong business profile as one of only two large commercial aircraft manufacturers, alongside Boeing. Although potential competitors are looking to enter 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 for over 6,700 aircraft representing 11 years of production following the 2016 Farnborough Airshow, providing significant visibility of production rates and revenues despite potential volatility in orders.

Cash Flow Improvement Expected

Airbus's FY2015 FFO margin of 6.8% was below our expectations for the rating, with losses on new programmes diluting profitability significantly. We expect cash generation to remain weak in 2016 as the A350 continues to incur early delivery losses and the A330 programme operates at low production rates and pricing prior to transition to the A330neo.

Fitch expects Airbus to demonstrate the ability to improve its FFO margin to over 9% to maintain the rating. We expect increasing delivery rates and cost improvement to boost cash generation from 2017, and forecast FFO margin to approach 10% by 2019.

FCF is likely to be around breakeven in 2016 as the company is likely to see a rise in inventory levels related to the A350 and A320neo programmes, and is unlikely to see the same level of customer advance inflows as in recent years. We also expect capex to decline after 2017 as product development decreases, moving towards 3% of revenues in 2019, from 4.5% in 2015. 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

Should problems persist in Airbus's key programmes, we may revise down our expectations of improvements in cash generation from 2017 and take negative rating action. Airbus is entering a key stage in ramping up production in its A350 and A320neo programmes. We have assumed that problems with the A320neo's engines are short-term and minor in nature and will be resolved imminently. We also assumed that resolution of A350 supplier issues would have resulted in 2015 deliveries being close to the 50 units guided by management.

Significant cash balances allow for inventory build-up of largely complete aircraft while awaiting final parts without challenging liquidity. We expect possible A380 losses due to reduced delivery rates to be significantly outweighed by improvements in other key product areas, and the programme's breakeven delivery rate will be supported by the strength of USD vs. EUR.

Asset Sales Focus Portfolio

Significant growth in the civil business at a time of declining government defence budgets has resulted in the defence segments representing a smaller proportion of the business. The sale of the remaining Dassault stake, defence electronics and civil satellites businesses will lead to a focus on the group's core civil aerospace competency. We expect a significant portion of the sale proceeds to be distributed to shareholders once cash requirements for ramping up and transitioning programmes are accounted for.

Currency Mismatch

Airbus maintains a large hedging portfolio as it derives a significant portion of its revenue in USD rather than in its chief cost currency (EUR. 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.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Airbus include:

- Mid-single digit revenue growth in 2016 as a result of A350 delivery ramp-up and A330 ramp-down

- Stable earnings margins in 2016 due to early delivery A350 losses, gradually increasing in 2017 and 2018 as A350 losses recede and A320neo deliveries ramp up

- Net disposal proceeds of around EUR2.6bn over 2016-2017

- Remaining EUR700m of existing share buyback programme completed in 2016, a further EUR1bn in 2017.

- Capex of EUR3bn in 2016 and falling towards EUR2bn by 2019

RATING SENSITIVITIES

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%

-FFO-adjusted leverage sustained above 2x

-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)

-Significant improvement in Airbus's currency mismatch position.

LIQUIDITY

At end-1Q16 Airbus had cash of EUR15.bn, including investments (both short - and long-term) of EUR11.3bn and excluding Fitch's EUR3bn adjustment for operational cash requirements. Short-term financing liabilities totalled EUR5.2bn. FCF is expected to remain negative in 2016 before increasing from 2017. Liquidity is bolstered by EUR3bn of long-term committed credit lines and sound access to the capital markets, illustrated by the July 2016 exchangeable bond and May 2016 EUR1.5bn 10-15-year bond issuance.