Fitch Ratings has assigned Leonardo S.p.A.'s new multi-currency commercial paper programme (CP) a 'F3' senior unsecured short-term rating.
The senior unsecured CP rating is in line with Leonardo's 'F3' Short-Term Issuer Default Rating, as the programme will be a direct, unconditional, unsubordinated and unsecured obligation of Leonardo S.p.A., and rank pari passu with all of the company's other outstanding unsecured and unsubordinated obligations.
The new CP will be issued by Leonardo S.p.A., and have an outstanding principal amount that will not exceed EUR1 billion (or the equivalent in other currencies) at any time. The proceeds from the three-year programme will be used for general funding purposes, and will be governed by and construed in accordance with Italian law.
Key Rating Drivers
Cash Flow Recovery Imminent: Fitch expects the EBITDA and funds from operations (FFO) margins to recover in 2022 to around 11% and 9%, respectively, gradually rising in subsequent years due expected pandemic recovery, rising production in commercial aerospace markets and the benefits from recent restructuring measures. Fitch expects Leonardo will have had EBITDA and FFO margins of around 11.5% and 9.5% in 2023, above the present downgrade sensitivities of 10.0% and 9.0%, respectively.
FCF to Turn Positive: Fitch believes Leonardo's free cash flow (FCF) margin is likely to be above 3% through the medium term, as core operating margins improve, working capital outflows subside and the company maintains capex discipline. In its projections, Fitch expects the company to return to a moderate dividend pay-out policy in 2022. Leonardo's FCF margin was -0.4% in 2020 and around 1% in 2021. We expect it to be around 3% in 2022 as a result of better cost containment, lower working capital outflows and a conservative dividend policy.
Underperforming Segments Likely Hit Bottom: Some of Leonardo's divisions, including aerostructures and regional jets, were significantly affected by the downturn in commercial aerospace, to which they are overwhelmingly exposed.
Fitch believes the cash burn at these segments, estimated at around EUR350 million in 2021, has peaked and will gradually return to break-even by end-2025. Furthermore, the aerostructures and Avions de transport regional (ATR) segments made up less than 5% of consolidated EBITA prior to the pandemic, and are more than offset by defence-oriented businesses, which contribute stronger and more stable cash flow through the cycle.
Leverage Expected to Improve: Leonardo's leverage weakened during the pandemic as a result of lower cash flow, which Fitch considers weak for the rating. Fitch estimates that gross and net EBITDA leverage were around 2.6x and 1.8x, respectively, at end-2022, while FFO gross and net leverage were 3.0x and 2.1x, respectively, with both net leverage ratios above Fitch's downgrade sensitivities of 1.5x and 2.0x, respectively.
However, Fitch believes that both gross and net leverage will improve materially in 2023 as earnings recover, with both EBITDA and FFO net leverage ratios likely to be around 11.5% and 1.7x at end-2023. Fitch assumes that the EUR606 million acquisition of the 25.1% stake in Hensoldt AG in January 2022 was funded from cash reserves. The company is exploring the possibility of asset sales, but Fitch does not include any meaningful net debt reduction from asset disposals in the short term in its rating case.
Well Diversified Business Profile: Leonardo is a large, diversified aerospace and defence company, with a revenue base well split between helicopters, defence electronics and aeronautics. The company has fairly strong geographical diversification: Italy accounted for 17% of 2021 revenue, the US 25%, the UK 9%, the rest of Europe 22%, and the rest of the world 27%. Leonardo is one of the world's leading helicopter manufacturers, a key partner in a number of strategic defence programmes, including Eurofighter, and 25% owner of missile manufacturer MBDA, which has a strong and predictable earnings profile.
Strong and Resilient Backlog: Leonardo benefits from a large and diversified order book, which at end-2021 stood at over EUR35.5 billion, or approximately 2.5x expected 2022 revenue. To date, it has not experienced a material decline in the backlog as a result of cancellations, with net book-to-bill in 2021 of around 1x and the backlog broadly in line with end-2020 levels. The strength of the backlog is further supported by its almost equal spread across the three main divisions of helicopters, aeronautics and defence, electronics and security.
Leonardo operates as both prime contractor and supplier in the aerospace and defence industry, and its helicopter business is considered top-tier. Its scale and visibility in the defence sector are lower than of BAE Systems plc (BBB/Stable) and Northrop Grumman Corporation (BBB+/Stable), making it less likely to lead the largest-scale projects. However, it has good positions in major programmes including Eurofighter and MBDA via partnerships and joint ventures.
Leonardo's credit metrics are comparable with MTU Aero Engines AG (BBB/Stable), with Leonardo possessing better diversification and scale. L3Harris Technologies (BBB+/Stable) has stronger through-the cycle margins than Leonardo, and its diversification is comparable, but its leverage remains high. Leonardo also has a strong balance between military and civil sales, and good geographical diversification compared with US defence contractors, for whom the majority of sales are US-focused.
As Leonardo has sold its most cash-absorbing operations and is restructuring those in which profitability was or is weak, it has made significant progress in improving its profitability, which is now largely in line with investment-grade peers.
Revenue to rise around 4% in 2022, driven primarily by growth in defence electronics;
An increase in reported EBITA and FFO margins in 2022 as a consequence of better capacity utilisation and recovery from the pandemic, followed by a gradual lift in the margin, which will nevertheless continue to be pressured by the loss-making aerostructures segment;
Broadly stable movements in working capital cash flows in 2022 and 2023, in line with revenue changes;
Hensoldt to pay a moderate dividend to Leonardo from 2022 onwards;
No significant asset disposals;
No change to dividend policy, which is expected to remain moderate;
Some previously deferred capex to occur in 2022, with capex returning to under 4% of revenue per year in 2023; and
All maturing debt to be refinanced in the short to medium term.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
EBITDA margin above 12% on a sustained basis;
FFO margin above 11% on a sustained basis;
FCF margin consistently around 3%;
EBITDA net leverage below 1.0x on a sustained basis;
FFO net leverage below 1.5x on a sustained basis.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
EBITDA margin below 10%;
FFO margin below 9%;
FCF margin consistently around zero;
Further material cash restructuring charges;
EBITDA net leverage above 1.5x on a sustained basis;
FFO net leverage above 2.0x on a sustained basis.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: Leonardo held cash of EUR383 million at end-1Q22. Net debt was EUR4.8 billion (end-2021: EUR3.1 billion), although around EUR956 million of this was related-party debt owed to JVs. Liquidity was strengthened following the signing of a new EUR2.4 billion dual-tranche revolving credit facility in September 2021, which matures in 2024 (EUR600 million) and 2026 (EUR1.8 billion), as well as a new five-year ESG-linked EUR600 million term loan maturing in 2027, which was used to refinance the EUR550 million bond maturing in January 2022.
The recently issued three-year EUR1 billion CP programme should allow Leonardo to further diversify its short-term funding instruments for the financing of its working capital needs.
Leonardo is an Italy-based group engaged in the design and manufacture of helicopters, defence electronics, civil and military aircraft components, aerostructures, satellites, space infrastructures, and missiles. It is a leading company in the European aerospace and defence industry and participates in many of the biggest international programmes through well-established alliances with European and American partners.
Date of Relevant Committee
28 July 2022
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
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