Fitch Rates Downer's Upcoming AUD MTN 'BBB(EXP)'
The planned notes will be issued under Downer Finance's AUD750m Debt Issuance programme. The final rating is contingent upon receipt of the final documentation conforming materially to information already received, and details regarding the amount.
The notes will be unconditionally jointly and severally guaranteed by Downer EDI Limited (Downer, BBB/Stable) and its subsidiaries, currently representing at least 90% of the group's consolidated total tangible assets and EBIT. As a result of this guarantee structure, Fitch regards the credit risk associated with the notes to be the same as that of the senior unsecured obligations of Downer itself.
KEY RATING DRIVERS
Order book to benefit from Tenix acquisition: Downer's order book remains strong and its project mix reflects the transition of demand for engineering services from the resources sector to other parts of the economy. On 4 February 2015, the company announced that it had signed a 10 year, AUD1bn agreement with Pacific National to provide a full suite of asset management services for over 300 of their locomotives.
Niche in Human Capital: One of Downer's core competencies is the managing of human capital related to major construction and maintenance projects. Downer has leveraged this competitive advantage in labour intensive segments such as electrical and instrumentation work, as well as infrastructure maintenance services. This skill set has universal application and is the 'rubber hitting the road' part of most projects, and complements the intellectual capital and knowledge base of larger contractors like Leighton and Lend Lease.
Increased Project Risk Oversight: Project delivery governance has improved with Downer's senior management (CEO, CFO, Audit and Risk Committee and Chief Risk Officer) having direct visibility of the delivery of all material projects. This allows for mishaps to be diagnosed and remediated at infancy to avoid major cost blowouts. The bid stage has also been made more robust through a tight legal, insurance, treasury, tax and accounting vetting process. This level of scrutiny for all material project bids means that Downer can make educated decisions on the allocation of capital. Evaluating the project from all these dimensions is the single best mitigating factor to a material contract loss.
Downer has a very granular project risk evaluation process with projects above the threshold of AUD30m being reviewed by the Group's Tenders and Contracts Committee (TCC), chaired by Downer's Chief Risk Officer. Downer's Board screens and approves all bids larger than AUD250m. This level of oversight reduces the agency risk associated with revenue based incentive structures.
Fitch's key assumptions within our rating case for the issuer include:
- Revenue growth in line with GDP growth;
- No significant contract losses; and
- Fitch estimates EBITDA margin in the range 7%-8% for 2015-2017.
Positive: Fitch does not envisage any positive rating action in the medium term given Downer's geographic concentration and scale, which constrain the rating at the current level.
Negative: Future developments that could lead to negative rating action include:
- An increase in leverage, as measured by adjusted net debt/operating EBITDAR, rising above 2.5x (1.78x FY14);
- EBITDA margin falling below 7% (8% FY14) both on a sustained basis; or
- Change to the business risk profile such that there is a material increase in Downer's exposure to fixed price construction contracts.