Fitch Rates Huntington Ingalls' Proposed Unsecured Notes 'BB+EXP'/'RR4'
Proceeds will be used to fund a tender for HII's outstanding 7.125 % senior unsecured notes due 2021. HII's total debt will remain unchanged after the transactions, and Fitch's ratings will cover approximately $1.3 billion of outstanding debt after giving effect to the new issuance and the expected repayment of the existing notes.
HII's existing ratings are listed at the end of this release. The Rating Outlook is Stable.
The indenture governing the proposed notes will have significantly different restrictive covenants from those governing the currently outstanding $600 million 7.125% senior unsecured notes due 2021, but it will be largely in line with the indenture governing the $600 million 5% senior unsecured notes due 2021. The restrictive covenants for the new notes will contain a change of control provision, limitation on liens and certain other customary limitations. However, unlike the covenants in the existing indenture, they will not limit the company's ability to raise additional unsecured debt, pay dividends or repurchase shares. Additionally, the new notes will not be subject to interest coverage and leverage ratios. Fitch views the change in covenants as credit neutral for HII.
KEY RATING DRIVERS
Ratings are supported by solid free cash flow generation (FCF - operating cash flows less CapEx and dividends), a large backlog, and strong credit metrics for the current ratings. For the last 12 months (LTM) ending June 30, 2015, the company had gross leverage (debt over EBITDA) of 1.6x, down from 1.9x and 2.3x at the end of 2014 and 2013, respectively. On July 13, 2015, the company amended and restated its credit agreement effectively increasing its revolving credit facility to $1.25 billion from $650 million. Simultaneously, the company repaid $345 million of term loans outstanding under the previous credit facility. Fitch estimates HII's leverage will be 1.3x at the end of the third quarter after giving effect to the repayment of the term loans. Fitch expects the company's leverage will remain stable over the next several years.
The ratings are also supported by the improving operating performance due to cost reduction initiatives and improved execution, and HII's plan to diversify revenues from its exposure to the U.S. government's military spending by making medium-sized acquisitions. Additionally, the company has a significant role in the U.S. Navy's 30-year shipbuilding plan released in April 2015.
Fitch's rating concerns for HII include low customer and product diversification and a significant exposure to program execution risk as evidenced by the underperformance of its Ingalls segment from 2010 to 2012 due to troubles with LPD and LHA ships. Additional concerns include large annual net working capital swings, increased dividends, and the company's exposure to risks to core defense spending after fiscal 2015. HII generates nearly all of its revenues from the U.S. government, exposing the company to changes in plans regarding the fleet needs of the Department of Defense and the Department of Homeland Security. In addition, Fitch is concerned with future cash deployment actions as the company continues refining its cash deployment strategy.
The notching up of the senior secured credit facility by one rating level from the IDR of 'BB+' to 'BBB-' is supported by the coverage provided by HII's tangible assets and operating EBITDA compared to the fully drawn facility. The collateral for the facility includes substantially all of HII's assets with the exception of the Avondale shipyard and a few other exclusions.
Fitch's key assumptions within the rating case for HII include:
--Low single-digit annual revenue growth;
--Steady EBITDA margins in the range of 13% to 14%;
--Dividend payments increase steadily over the next several years, and Fitch does not anticipate material share repurchases;
--Post-dividend FCF margin will remain within the range of 3.5% to 4%;
--Capital expenditures will be in the range of 2.75% to 3.5% of revenues;
--Debt level will remain steady;
--Pension contributions will not be a significant portion of the company's cash deployment in the near future.
Fitch may consider a positive rating action if HII's overall credit metrics continue to strengthen, including if its leverage and FFO adjusted leverage decline and remain in the range of 1.25x-1.5x and 2x-2.5x, respectively. Fitch is not likely to take a positive rating action on HII until U.S. defense spending trends stabilize, the company has a defined cash deployment strategy, and it completes the Avondale shipyard closure.
Given the company's low diversification and its exposure to project execution risks, Fitch expects HII would need to maintain stronger than average credit metrics and financial flexibility in order to obtain investment-grade ratings.
A negative rating action is not likely in the near future; however, it would be considered should the company's leverage and FFO adjusted leverage increase and remain above 2.5x and 3.5x, respectively. Other metrics in addition to leverage would also be considered in determining negative rating actions.
The company has a strong liquidity position. As of June 30, 2015, HII had liquidity of $1.6 billion, including $960 million in cash and $620 million of availability under its $650 million revolving credit facility, after giving effect to $30 million of outstanding letters of credit. Fitch estimates the company's liquidity will increase to approximately $1.9 billion at the end of the third quarter of 2015 after giving effect to the higher limit of the revolving credit facility and lower cash balances following the repayment of the term loans.
FULL LIST OF RATING ACTIONS
Fitch currently rates HII as follows:
--Senior secured bank facilities 'BBB-/RR1';
--Senior unsecured debt 'BB+/RR4'.
The Rating Outlook is Stable.