2009 N.A. Aerospace/Defense Outlook: Commercial Demand at Risk; Credit Outlook Stable
The slowdown in global economic growth will test the North American A&D industry in 2009, particularly on the commercial side, but Fitch Ratings considers the industry to be well-positioned to weather the downturn from a credit perspective. Large backlogs, strong credit metrics and healthy liquidity support the industry's credit profile.
Commercial aerospace markets are mixed, with the business jet and aftermarket segments most at risk, but Fitch's downside scenarios assume production rates could be weak even in the large commercial aircraft (LCA) and regional aircraft markets in the second half of 2009.
Department of Defense (DOD) spending levels are high after nearly ten years of substantial growth, but Fitch believes the spending upcycle has ended and, going forward, there will be modest core budget growth and gradually declining supplemental spending. Any impact from the 2008 elections will likely be delayed due to the timing of the budget process and other federal priorities such as the economy.
Fitch has rated the sector conservatively during the upturn over the past several years, taking into account the sector's cyclicality, and many of the companies possess very strong credit metrics for their current ratings. For example, Fitch estimates that most companies could withstand temporary EBITDA declines of 25% and still have credit metrics in line with the current ratings, assuming flat debt levels.
Liquidity and Cash Deployment
Most of the large A&D companies rated at Fitch have strong liquidity positions and financial flexibility, both of which will help the industry stand up to the weaker global economy in 2009. At the end of the third quarter, the top 15 North American A&D companies rated by Fitch had cash and equivalents totaling $27.5 billion, and another important player in the global industry, Europe-based EADS (BBB+, Outlook Stable), had cash and investments of Euro 12.9 billion.
Short-term debt and debt maturities for the top 15 North American companies totaled approximately $9 billion at the end of the third quarter, and total debt outstanding was about $55 billion. Most of the companies have committed, long-term credit lines, with only General Dynamics, L-3 and Raytheon having credit lines expiring in the next 18 months.
Given the difficult conditions in the credit markets, Fitch expects A&D companies to follow conservative cash deployment strategies in 2009 in order to build liquidity. Share repurchases, which totaled approximately $14 billion in the U.S. A&D industry in the first nine months of 2008, should decline, and Fitch expects constrained M&A activity beyond bolt-on acquisitions. Fitch expects debt levels to stay flat in the industry, although there is a large backlog of long-term debt issuance building up that will be used primarily to term out short-term debt. If the economy continues to weaken, restructuring actions may become a noticeable use of cash in 2009.
Pension contributions will also increase in 2009 because of the decline in financial markets in 2008, partially offset by higher discount rates. The pension situation in the defense sector is mitigated by the deferred implementation of certain elements of the Pension Protection Act of 2006 for some defense contractors and by the ability of defense contractors to include pension costs as allowable costs in defense contracts.
With industry conditions weakening, Fitch will increase its surveillance in 2009 of off-balance sheet (OBS) obligations. In addition to the pension situation mentioned above, these OBS items include backstop financing commitments, financial subsidiary support agreements, residual value guarantees, trade-in obligations and legal disputes.