KEY RATING DRIVERS
Key factors that support the ratings include GD's solid credit metrics, strong free cash flow (FCF; cash from operations less capital expenditures and dividends), financial flexibility and strong liquidity position, competitive position in business jets and defense, and large backlog. Another positive factor is the level of diversity in GD's portfolio of products and services, both domestically and internationally, including marine, ground combat systems and business jet businesses.
GD has a conservative balance sheet and disciplined operating strategy. The company maintained a strong credit profile through the recent downturn in the business jet sector and sizable reductions in U.S. military spending. The company steadily increased its cash balance from approximately
GD continues to reduce its exposure to the U.S. government by increasing international and commercial sales to 38% in 2013, up from 34% reported in 2012. The increasing commercial sales are fueled by the recovering business jet market, mitigating U.S. budgetary pressures and the expected decline in military spending. Fitch expects GD will increase its international and commercial sales in the next year.
Fitch notes a significant increase in the backlog of the company's Combat Systems segment due to a
Fitch is concerned by declining revenues and corresponding declines in cash generation, which are expected to remain under pressure due to the impact of sequestration and the uncertainty of the timing of international orders. GD is exposed to declines in core U.S. defense spending in fiscal 2016 and beyond. A dramatic unexpected change in U.S. defense spending policies would be a key driver of GD's credit profile, although Fitch believes that modest declines in defense spending would not necessarily lead to negative rating actions given GD's current credit metrics, liquidity position, and diversified product portfolio.
Additionally, GD has a sizable pension deficit somewhat mitigated by GD's strong cash generation. Fitch expects pension contributions to remain a sizable part of GD's cash deployment strategy. At the end of 2013, GD's defined benefit pension plans were
Acquisitions, share repurchases and dividend payments have been the focus of the company's cash-deployment strategy over the past several years, though the company moderated its share repurchases and acquisition activities in 2012 and 2013 before accelerating cash deployment this year. GD repurchased approximately
U.S. government spending trends are key drivers of GD's financial performance as the company generates approximately 62% of its revenues from the U.S. government, mostly from the
U.S. defense spending is projected to remain stable during fiscal 2014 and 2015 at the fiscal 2013 level driven by the Bipartisan Budget Act of 2013 which became law in late 2013.
Despite stabilization of the U.S. military spending budget, Fitch expects 2014 to be another challenging year for U.S. defense contractors. The sequestration cuts implemented in 2013 should have a negative effect on most defense contractors for the next several years because of the lag between appropriations and outlays and Fitch expects revenues of most defense companies will decline in fiscal 2014.
GD's exposure to DoD spending is mitigated by strong margins, solid FCF, good diversification within DoD's programs, strong and growing international and commercial sales at a combined 38% of total revenues in 2013, good liquidity and large backlog. Additionally, some of the concerns are mitigated by the recent awards of a
GD derived approximately 26% of 2013 revenues from business jet sector, the highest percentage of sales historically. The segment accounted for approximately 38% of the company's operating income, also the highest since the Gulfstream acquisition. Parts of the business jet market have not yet recovered from the recession; however, the sector showed significant improvement during the first half of 2014. The market is split between larger jets (which are doing well) and mid-size and small jets (which are still under pressure). The business jet sector remains weak overall compared to its peak, and despite a slight increase in deliveries in 2013 and during the first quarter of 2014, it is at risk in the event of an economic downturn, with small jets most at risk in Fitch's view.
In 2013, a total of 678 business jets were delivered compared to 672 deliveries in the prior year marking the first increase in deliveries since 2008, when an historic high 1,313 aircraft were delivered. Billings reflected the strength of the large and midsize segments, increasing 19.4% compared to only a 1% increase in deliveries.
According to the
GD is one of the industry's leaders in large jets. Through the downturn GD maintained profitability and continued developing the G280 and G650 programs, both of which received type certificates in 2012. GD also delivered the first fully outfitted G280 and G650 aircraft to customers in 2012. During the first half of 2014, GD's outfitted deliveries increased from 65 units to 77 units compared to the same period in 2013. The company's green delivers also increased from 65 units to 68 units during the first half of 2014.
Fitch would consider a negative rating action if the company's leverage (debt / EBITDA) or FFO adjusted leverage deteriorate and remain within the ranges of 1.3x - 1.5x and 2.1x - 2.3x, respectively, driven by a cancelation of a key program, significant downturn in the business jet sector, unsuccessful attempts to reduce costs in line with revenue reductions, or more aggressive debt funded cash deployment actions.
Fitch does not an anticipate an upgrade in GD's ratings because of the current uncertainty in the defense spending outlook and Fitch's expectation that the company's liquidity will decline due to cash deployment to shareholders.
Fitch affirms GD's ratings as follows:
--IDR at 'A';
--Senior unsecured debt at 'A';
--Credit facilities at 'A';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
David Petu, CFA, +1 212-908-0280
Source: Fitch Ratings
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