Finmeccanica’s drive to restore its fortunes after heavy 2011 losses in its rail transport and energy divisions combined with a €750 million write-down against its involvement in Boeing’s 787 programme has got mixed reviews from the main credit rating agencies, with Standard & Poor’s making the latest move, lowering the Italian aerospace and defence industry champion’s rating a notch to BB+/B, from BBB-/A-3 – taking its debt below the investment grade level.
S&P does, however, see Finmeccanica’s outlook as stable. Fitch has maintained its investment grade BBB- rating, but is holding its view of the group’s prospects as negative. And, Moody’s investment grade Baa3 rating, set in November 2012, remains in place, with the caveat that “key credit metrics remain very weak for the rating category”.
Key to all three agencies’ view of Finmeccanica is its progress toward hiving off unprofitable businesses in rail and energy and restructuring the rest of the group.
That plan, outlined at the end of 2011 and fleshed out last year, is to build the business around sectors where it is a market leader, and exit everything else unless market leadership can be achieved through partnership.
Broadly, the plan is to refocus on the successful AgustaWestland helicopter business, aeronautics – including a merger of the Alenia Aeronautica and Alenia Aermacchi civil and military aircraft units – and defence electronics and security, which will operate in the US under the banner of DRS, a business acquired in 2008 for $4.5 billion just before the financial crisis broke, and elsewhere by combining the various Selex companies into a single operation.
If the credit rating agencies’ perceptions are accurate, though, Finmeccanica faces a challenging 2013. S&P’s base-case assumption is that the group can “slightly improve” its operating profits (2011 earnings before interest and taxes was a negative €2.39 billion ($2.05 billion) including some heavy write-downs, but for the first half of 2012 EBIT stood at less than 5% of revenue, and was all but wiped out by interest and taxes), but it “no longer believes Finmeccanica’s credit metrics will improve” this year.
Moreover, S&P’s downgrade reflects its assumption that Finmeccanica will not in the near term achieve a financial risk profile consistent with the earlier, higher rating. And, S&P has already factored in operational and efficiency improvements achieved in 2012.
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Underlying the pessimism is the slow pace of restructuring. As S&P notes, in 2012 the group only achieved the sale of its 14% stake in engine components maker Avio, with €260 million proceeds – which had little impact on the group’s financial risk. The agency had been expecting Finmeccanica to net €1 billion from disposals in 2012, and use those proceeds to pay down debt.
Indeed, debt is clearly hanging over the company. S&P describes its fully adjusted debt of €7.87 billion as of 30 September as “sizeable”, at nearly 16 times EBITDAR and 45% of revenue. And, says S&P, that debt will have to be reduced before it considers raising Finmeccanica’s rating.
Debt repayment will depend on the completion of asset sales that have been expected but have yet to happen – the Ansaldo energy business, for example. S&P anticipates a slight improvement in operating performance in 2013, but does not expect that improvement to generate enough discretionary cash to pay down much debt.
And, there remains much risk on the downside when it comes to operating performance. Moody’s assessment is coloured by the hit to profitability from restructuring-related charges, along with the decline in revenues in the defence electronics division, which accounts for a third of sales but is suffering in the poor defence business environment, particularly in the USA.
Fitch, moreover, adds concerns about the ongoing Italian government investigation into defence exports corruption and bribery involving some senior Finmeccanica management. Fitch notes that adverse findings could undermine the company’s reputation, and also have an impact on management’s ability to focus on delivering the restructuring plan that is so crucial to a turnaround.
The impact of that bribery investigation should not be underestimated. One group insider has suggested to Flightglobal that at least one very senior Finmeccanica executive who is almost certainly innocent of any wrongdoing may nevertheless end up resigning, such is the political sensitivity of this affair in Italy.
Finmeccanica itself, meanwhile, insists it is on track to meet market expectations and reaffirms its 2012 guidance of revenue of €16.9-17.3 billion and EBITA of €1.1 billion. Those numbers would leave it just shy of 2011’s revenue performance, though pull EBITA back into positive territory.
The group also insists, rightly, that S&P’s downgrade has no bearing on the cost of servicing its existing loans and bond issues. And, it adds, its financial structure is “solid”, with an average debt life of over 10 years and no significant refinancing needs that will take it to the bond market before 2017.
To take a sanguine view of this situation, though, is to assume that those assumptions hold and Finmeccanica will not need to go to the market for cash. While holding its Finmeccanica rating for now, Fitch advises clients that announcement of further significant restructuring measures could spark a cash outflow, and it sees material risk in achieving the existing restructuring plan, along with targeted revenue, earnings and cash flow.
Should Finmeccanica fall short of plan, then, its credit ratings could well suffer. In that event, borrowing would get more expensive – potentially digging the debt hole that much deeper and raising the spectre of comparison with the budget travails of southern European eurozone members like, say, Finmeccanica’s native Italy.
In contrast, many of Finmeccanica’s peers look positively Teutonic or Nordic. In Fitch’s book, General Dynamics stands at A and stable, BAE Systems and Northrop Grumman at BBB+ and stable; even Thales, which has suffered its share of setbacks in the past couple years, also rates a BBB+, though with a negative outlook given the belief that its gradual improvement in margins and cash generation “may prove challenging to achieve in the given timeframe”.
A year ago, then newly appointed chief executive Giuseppi Orsi presented Finmeccanica’s 2011 results and solemnly promised never again to have to discuss such dreadful numbers. As he details the 2012 financials on 12 March he can be sure the number crunchers will be pressing him for hard timing details of Finmeccanica’s disposal plans, not to mention a good explanation for why so little headway was made during 2012.