Outlook remains stable
New York, December 06, 2012 -- Moody's Investors Service lowered the long-term senior unsecured debt rating of European Aeronautic Defence & Space Co. EADS and its subsidiary EADS Finance B.V. (collectively, EADS or the company), each to A2 from A1, following the company's announcement of proposed changes to its governance and ownership structure that are expected to be implemented in 2013. These changes include a maximum ownership limitation of 15% for any one party, but notably the wholesale elimination of any and all blocking or veto rights and the establishment of a new governance framework with just two members consented to by each of France and Germany on a newly constituted twelve-member board. When completed, the changes are expected to ultimately result in equal ownership and voting shares of 12% each for France and Germany (with France potentially retaining an approximate 3% incremental ownership stake, albeit without any associated voting rights on the incremental shares), each being lower than the effective voting interest previously exercised by France. Going forward, non-strategic public investors are expected to represent more than two-thirds of shareholder voting interests. "While EADS will continue to be strategically important for both the French and German governments, we believe the planned changes will result in a lower degree of government influence and control when implemented, and an increased emphasis on commercial objectives. Consequently, the rating downgrade reflects lower expectations for potential government support," noted Russell Solomon, Moody's Senior Vice President and lead analyst for EADS. The rating outlook remains stable.
Ratings affected include the following:
..Issuer: European Aeronautic Defence & Space Co. EADS
....Issuer Rating, downgraded to A2 from A1
....Euro Medium-Term Note Program, downgraded to (P)A2 from (P)A1
....Outlook, Stable, affirmed
..Issuer: EADS Finance B.V.
....Gtd. Euro Medium-Term Notes, downgraded to A2 from A1
....Gtd. Euro Medium-Term Note Program, downgraded to (P)A2 from (P)A1
....Outlook, Stable, affirmed
The A2 rating reflects one notch of uplift above Moody's assessment of EADS' stand-alone credit profile due to potential government support, down from two notches previously. Moody's baseline credit assessment (BCA) for EADS is unchanged at a3, reflecting the company's strong market position as a leader in aircraft production (airplanes, helicopters) with a sizeable and growing asset base; long-term revenue visibility associated with a very large backlog of orders totaling nearly EUR550 billion (albeit at list vs. contractual selling prices); and high-level financial flexibility afforded by a sizeable net cash position and strong liquidity profile. Moody's assessment of the company's key credit strengths continues to be somewhat constrained, however, by the company's relatively weak operating margins and asset returns, as well as only a moderate level of business diversification.
Moody's expects that the pending changes in ownership, voting and governance will result in a stronger emphasis on financial performance and returns over time. However, Moody's did not revise its assessment of EADS' stand-alone credit worthiness because the rating agency expects that the requisite level of material improvements needed to substantiate a higher (a2) BCA will occur gradually over several years, and further that the company's increased responsiveness to non-strategic shareholders may also increase the potential for share repurchases or business acquisitions that would limit improvement in its financial profile.
Moody's continues to categorize EADS as a government-related issuer (GRI). EADS' A2 rating considers the following factors that have not changed: the a3 baseline credit assessment of stand-alone credit strength; sovereign ratings of Aaa for Germany and Aa1 for France (both with a negative outlook); and Moody's assessment of low default correlation with the sovereign owners. The rating also considers Moody's view that the likelihood of extraordinary support is now moderate, while previously it had been assessed as strong.
Moody's expects improvements in EADS's performance over the next three years. Specifically, EADS' A380 (very large commercial widebody airplane) and A400M (military cargo/transport aircraft) programs are expected to be less cash absorptive going forward. Although these programs will likely continue to consume capital -- especially the A380, which has an issue with cracks appearing in the wing ribbing and for which EADS expects to incur incremental charges approximating EUR260 million in 2012 -- the company's cash requirements are expected to be much lower than in previous years. In addition, the company's A350XWB development program -- recently delayed by another three months, with entry-into-service now scheduled for the third quarter of 2014 -- will require considerable investment as production ramps up over the coming years. Taken together, Moody's believes these large cash outflows coupled with normal course volatility in order rates and associated pre-delivery payments could render EADS free cash flow negative for the year and slow the company's anticipated growth, hindering its full free cash flow generating ability over the near term.
However, Moody's expects EADS to be able to more than offset these constraining factors with the strong cash flows that the company is likely to generate from its older, in-production commercial aircraft programs (A320, A330). The production rates for these programs have either recently ramped up (A320, to a record high 42/month during the fourth quarter of 2012) or are scheduled to do so (A330, to 10/month by April 2013, and possibly 11/month by 2014). Development costs for the A320neo (the fastest-selling plane in Airbus' history, with expected entry-into-service during the second half of 2015) should be manageable and fully accommodated within EADS' financial profile.
Moody's believes EADS will be able to successfully execute on its scheduled commercial production ramp-ups and convert its substantial backlog into higher levels of aircraft deliveries and cash flows over the next 12- to 24-months, a key factor underpinning its a3 BCA. This is notwithstanding concerns about supply-chain management and further potential disruptions, along with some ongoing risk related to the availability of aircraft financing and requisite international capital markets development.
Moody's notes that several of EADS' key credit metrics are already substantially improved from last year, particularly debt/EBITDA which now stands at around 2.0x, and retained cash flow/debt which approximates 44%. Moody's anticipates that EADS will achieve further improvements in most of its quantitative credit metrics over the next two years. The rating agency also considers that EADS will continue to make slow progress towards achieving operating margins that are more comparable to those of its peers (i.e., high single-digit levels).
The stable outlook reflects Moody's expectation that EADS will continue to de-risk its development programs and successfully execute its multiple business lines in an increasingly profitable manner while maintaining a strong liquidity profile.
WHAT COULD CHANGE THE RATING UP/DOWN
Although not expected over the extended rating horizon, EADS' ratings could warrant consideration for potential upgrade if the company evidences operating performance improvements such that it demonstrates sustainable high single-digit operating margins (now around 4%), debt/EBITDA of less than 1.5x and meaningful free cash flow generation while continuing to deliver on its new programs and maintaining a strong liquidity profile.
Conversely, negative rating pressure could arise as a result of a reversal of recent favorable trends and an accompanying deterioration in EADS' operating profitability, a lack of steady progress by the company towards achieving operating margins at least in the mid-single digits in percentage terms, an acceleration in aircraft cancellations that significantly curtails EADS' sizeable backlog, or if the company experiences further production problems with any of its large programs and a strong liquidity profile is not maintained. A material lowering of Moody's support assumption, such as might result from a substantial incremental reduction in government ownership, could also result in a downgrade by eliminating the one notch of uplift that is currently incorporated and ascribed to such ownership.
The principal methodology used in rating European Aeronautic Defence & Space Co. EADS, and EADS Finance B.V., was the Global Aerospace and Defense Industry Methodology published in June 2010. Other methodologies used include the Government-Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.
Headquartered in Toulouse, France, EADS is a leading aerospace company through its principal Airbus operating subsidiary (approximately two-thirds of revenue, and growing), which is one of only two global producers of large commercial airplanes (The Boeing Company, A2 stable, being the other). Eurocopter (the world's largest helicopter maker), Cassidian (defense and security) and Astrium (military telecommunications and ballistic missiles) provide some diversification, although EADS is principally exposed to the commercial aviation cycle. EADS had turnover of approximately EUR54 billion during the 12-month period ended September 2012.
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Russell Solomon Senior Vice President Corporate Finance Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653Michael J. Mulvaney MD - Corporate Finance Corporate Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
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