Overview

  • Aerojet Rocketdyne Holdings Inc.'s credit ratios have been improving steadily and exceeded our previous expectations over the past year due to better margins and debt reduction.
  • We are raising our corporate credit rating to 'B+' from 'B'.
  • The positive outlook reflects the possibility that we could raise the rating if new business wins cause the company's long-term competitive position to improve or if credit ratios improve further, with funds from operations (FFO) to debt above 30%.

Rating Action

On Nov. 22, 2016, S&P Global Ratings raised its corporate credit rating on 
Aerojet Rocketdyne Holdings Inc. to 'B+' from 'B' and revised the outlook on 
the corporate credit rating to ppositive from stable. 

At the same time we raised the issue level rating on the subordinated notes to 
'B-' from 'CCC+', while maintaining the recovery rating at '6'.

Rationale

The upgrade reflects Aerojet's credit metrics improving much faster than we 
expected due to improving margins and lower debt after refinancing earlier in 
2016. We now expect FFO to debt to be 22%-28% and debt to EBITDA to be 2.7x- 
3.2x in 2016, compared with our previous expectations of FFO to debt around 
15% and debt to EBITDA 4.3x-4.8x. They are levels that will exceed our upgrade 
triggers. Adjusted debt levels have declined over $120 million since the end 
of fiscal 2015, as the company used excess cash to pay down debt and $43 
million of convertible notes were converted into equity. We expect credit 
ratios to continue to improve in 2017 with modest revenue and earnings growth 
and further debt repayment.

Despite its recent success in improving earnings, we believe the loss of 
certain contracts in 2015 and changing market dynamics have increased 
uncertainty about the company's long term earnings potential and competitive 
position. Last year, United Launch Alliance (ULA) selected Orbital ATK to 
replace Aerojet as its supplier of solid rocket boosters on the Atlas V (and 
the Vulcan rocket that ULA is developing to replace the Atlas) starting in 
2019. This was a major program for Aerojet, accounting for about 7% of overall 
revenues. In addition, Orbital ATK terminated a contract with Aerojet to 
supply its AJ-26 engines, which were used on Orbital's Antares rocket, 
following a 2014 launch failure. While this program only accounted for a small 
portion of Aerojet's total sales, we believe that it represents lost future 
opportunities for the company. . 

On top of these lost contracts, shifting industry dynamics have made the 
company's markets more competitive. Orbital Sciences, one of Aerojet's 
customers, merged with Alliant TechSystems, one of Aerojet's competitors, in 
2015, which has made it more difficult for Aerojet to win future 
solid-propellant engine work with Orbital. SpaceX is also an emerging 
competitor that makes entire rocket systems, including engines, and the 
company is pushing to secure the contracts to launch military satellites 
currently dominated by ULA. 

In February 2016, Aerojet won a U.S. Air Force contract for development of the 
AR1 rocket engine to replace the Russian RD-180 for the Atlas V. This project 
entails a total investment of $804 million, with $536 million provided by the 
Air Force and $268 million provided by Aerojet and its partners (primarily 
ULA). The development is likely to be completed by the end of 2019. If the 
company wins the down-select next year over Blue Origin, a privately funded 
start up, production revenues will begin in 2020. Winning this program would 
largely offset the loss of the Atlas V boosters  and provide some long-term 
revenue visibility. 

The company's three other key programs include two missile programs (THAAD and 
Standard Missile) and NASA's Space Launch System (SLS), being developed to 
launch humans into deep space. Missile programs are seeing high demand from 
the U.S. and international governments, while the SLS remains a high priority 
for NASA, though it could be a target for future spending cuts given its large 
size. Beyond that, Aerojet's program diversity is fairly good.

Our base case forecast assumes: 
  • Low-single-digit percent revenue growth each of the next two years driven by missile programs and new business wins;
  • EBITDA margins improving to 14%-15% over the forecast period due to the cost reduction plan being implemented and improving operating efficiency on existing programs;
  • No share repurchases or dividends over the next two years and no planned mergers and acquisitions activity;
  • Modest debt reduction; and
  • No real estate sales through 2017.
This results in the follow key credit metrics:
  • Debt to EBITDA of 2.7x-3.2x in 2016 and 2.2x-2.7x in 2017; and
  • FFO to debt of about 25%-30% through 2017.
Liquidity
We assess Aerojet's liquidity as adequate. We expect liquidity sources to be 
at least 1.2x uses over the next 12 months. In addition, we believe that 
sources would exceed uses even if EBITDA were to decline by 15%. Aerojet has 
substantial real estate holdings that could bolster liquidity if sold, 
although the timing and amount is difficult to predict. We also expect the 
company to maintain adequate cushion in the covenants in its credit facility 
for the foreseeable future.

Principal liquidity sources:
  • Cash of $129 million as of Sept. 30, 2016;
  • $205 million of availability under the $350 million revolver; and
  • Cash from operations of $50 million-$60 million in the next 12 months.
Principal liquidity uses:
  • Capital spending of $30 million-$40 million; and
  • $20 million per year amortization on the term loan.

Outlook

The positive outlook reflects our expectation that credit metrics will 
continue to improve modestly over the next 12 months, with FFO to debt of 
25%-30% and debt to EBITDA below 3x. It also reflects thee possibility that 
new business wins and growth on other programs could improve the company's 
long-term competitive position.

Upside scenario
We could raise the rating if new business wins and growth on key programs 
improve the company's long-term competitive position, while it maintains at 
least the current level of credit ratios, including FFO to debt above 25%. We 
could also raise the rating if margin improvement resulting from cost 
reduction efforts and further debt reduction results in FFO to debt staying 
above 30%.

Downside scenario
We could revise the outlook to stable if the company is not able to win key 
new programs, such as a production contract for the AR1 engine currently in 
development, or loses any major existing programs, such that we believe its 
long-term competitive position remains in question. We could also revise the 
outlook back to stable if credit metrics deteriorate due to operating problems 
or higher debt-to-fund acquisitions, including FFO to debt declining back to 
around 20%.

Ratings Score Snapshot

Corporate Credit Rating: B+/Positive/--

Business Risk: Weak

  • Country Risk: Very low
  • Industry Risk: Intermediate
  • Competitive Position: Weak
Financial Risk: Significant

Cash flow/leverage: Significant

Anchor: bb-

Modifiers:

  • Diversification/portfolio effect: Neutral (no impact)
  • Capital Structure: Neutral (no impact)
  • Liquidity: Adequate (no impact)
  • Financial Policy: Neutral (no impact)
  • Management and governance: Fair (no impact)
  • Comparable rating analysis: Negative (-1 notch)

Recovery Analysis

Key analytical factors
  • Our simulated default scenario assumes a payment default in 2020 due to funding cuts for key programs and cost overruns that reduce profitability such that the company is no longer able to meet its fixed charges, including interest expense, maintenance capital spending, and required debt amortization. We assume the EBITDA at emergence is higher than the fixed charge proxy because we believe the company would be able to rationalize its cost structure in bankruptcy.
  • Other key default assumptions include an increase in LIBOR to 350 basis points (bps), a 150 bps increase in the margin on the first-lien debt due to covenant amendments, 85% revolver draw, and all debt includes six months of accrued interest. It also does not include any value for the company's real estate holdings.
Simulated default assumptions
  • Simulated year of default: 2020
  • EBITDA at Emergence: $110 million
  • EBITDA Multiple: 5x
Simplified waterfall
  • Net enterprise value (after 5% admin. costs): $523 million
  • Valuation split in % (obligors/nonobligors): 100/0
  • Priority claims: 0
  • Value available to first-lien debt claims (collateral/noncollateral): $522 million/0
  • Secured first-lien debt claims: $575 million
  • Recovery expectations: N/A
  • Structurally subordinated debt claims: $43 million
  • Recovery expectations: 0%-10%

Related Criteria


Ratings List

Upgraded; CreditWatch/Outlook Action
                                        To                 From
Aerojet Rocketdyne Holdings Inc
Corporate Credit Rating                 B+/Positive/--     B/Stable/--

Upgraded; Recovery Ratings unchanged 
                                        To                 From
Aerojet Rocketdyne Holdings Inc
 Subordinated                           B-                 CCC+
  Recovery Rating                       6                  6


Certain terms used in this report, particularly certain adjectives used to 
express our view on rating relevant factors, have specific meanings ascribed 
to them in our criteria, and should therefore be read in conjunction with such 
criteria. Please see Ratings Criteria at www.standardandpoors.com for further 
information. Complete ratings information is available to subscribers of 
RatingsDirect at www.globalcreditportal.com and at www.spcapitaliq.com. All 
ratings affected by this rating action can be found on the S&P Global Ratings' 
public website at www.standardandpoors.com. Use the Ratings search box located 
in the left column.

Primary Credit Analyst:Christopher A Denicolo, CFA, Washington D.C. (1) 202-383-2398;
christopher.denicolo@spglobal.com
Secondary Contact:Isha Bagga, CFA, New York (1) 212-438-0136;
isha.bagga@spglobal.com

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