- 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%.
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'.
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.
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.
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.
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%.
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)
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
- 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%
- Criteria - Corporates - General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers – Dec. 16, 2014
- Criteria - Corporates - Recovery: Revised Revolver Usage Assumptions For Recovery Analysis In Corporate Ratings – Nov. 20, 2014
- Criteria - Corporates - Industrials: Key Credit Factors For The Aerospace And Defense Industry - March 25, 2014
- Criteria - Corporates - General: Corporate Methodology: Ratios And Adjustments – Nov. 19, 2013
- General Criteria: Methodology: Industry Risk – Nov. 19, 2013
- General Criteria: Group Rating Methodology – Nov. 19, 2013
- Criteria - Corporates - General: Corporate Methodology – Nov. 19, 2013
- General Criteria: Country Risk Assessment Methodology And Assumptions – Nov. 19, 2013
- General Criteria: Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers - May 7, 2013
- General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers – Nov. 13, 2012
- General Criteria: Use Of CreditWatch And Outlooks – Sept. 14, 2009
- Criteria - Corporates - Recovery: Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt – Aug. 10, 2009
- Criteria - Corporates - General: 2008 Corporate Criteria: Rating Each Issue - April 15, 2008
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;|
|Secondary Contact:||Isha Bagga, CFA, New York (1) 212-438-0136;|
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