Fitch Rates Proposed General Dynamics Senior Unsecured Notes 'A'
Fitch Ratings has assigned an 'A' rating to General Dynamics Corporation's (GD) planned issuance of:
--$900 million 1% senior unsecured notes maturing 2017;
--$1 billion 2.25% senior unsecured notes maturing 2022;
--$500 million 3.6% senior unsecured notes maturing 2042.
Proceeds will be used to redeem a total of $2.4 billion of senior unsecured notes maturing from 2013 to 2015 and for general corporate purposes. The Rating Outlook is Stable. A full rating list appears at the end of this release.
Key factors that support the ratings include GD's solid credit metrics, strong free cash flow (FCF; cash from operations less capex less dividends), financial flexibility and liquidity position, high defense spending levels, competitive position in business jets and defense, and large backlog. Other positive factors include the high level of diversity in GD's portfolio of products and services, both domestically and internationally, including marine, ground combat systems and business jet businesses.
GD's conservative financial profile and effective operating strategy helped the company maintain a strong credit profile through the economic downturn, and GD outperformed many of its peers, particularly in the business aviation sector.
Fitch's concerns include:
--Risks to core defense spending and the overhang of potential automatic cuts beginning in early 2013 related to the 'sequestration' situation;
--GD's cash deployment strategy, which includes a focus on acquisitions, dividends and share repurchases, mitigated by management's recent comments regarding a cautious cash deployment strategy ahead of the sequestration deadline;
--Cyclical weakness in parts of the business jet market;
--The sizable pension deficit (60% funded at the end of 2011), somewhat mitigated by GD's strong cash generation and the recently enacted MAP-21 Act, which may have a positive short term impact on minimum cash contributions to the pension plan if GD decides to take advantage of it.
Fitch expects the company to maintain solid credit metrics with liquidity above $4 billion and leverage (debt to EBITDA) of approximately 0.9 times (x). In 2011, GD increased its debt level by $750 million ($1.5 billion debt issuance net of $750 million debt retirement). Despite the additional debt, GD has a strong financial position for the rating. The proposed debt issuance is not expected to change GD's leverage as proceeds will be used to redeem outstanding senior notes.
GD acquired six businesses during the first three quarters of 2012 for approximately $426 million and six businesses in 2011 for approximately $2 billion (approximately $1.6 billion of which was in 2011). Fitch expects GD will continue its bolt-on acquisition strategy, however, Fitch does not expect a major acquisition which would require debt financing. Fitch's financial projections incorporate significant spending for acquisitions and share repurchases, but this spending should be satisfied with FCF.
GD's FCF (cash from operations less capital expenditures and dividends) has historically been strong due to solid operating performance and working capital management. In the last 12 months (LTM), ending in the third quarter of 2012, the company generated $2.6 billion of FCF. FCF totaled approximately $2.1 billion in 2011 and $2 billion in 2010. Fitch expects GD to generate approximately $1.5 billion to $2 billion of FCF annually.
At the end of 2011, GD's pension plans were $4 billion underfunded, or approximately 60% funded. GD contributed approximately $350 million to its pension plans in 2011 and $300 million in 2010. The company contributed approximately $430 million to its plans during the three quarter of 2012 and expects to contribute approximately $70 million in the fourth quarter. The large pension deficit is mitigated by GD's strong cash generation and liquidity position. Fitch believes future cash contributions will not have significant effect on the company's cash deployment strategy.
GD participates in two key market channels: defense and business jets. Even though GD's revenues are heavily weighted towards defense, the Aerospace segment typically has the company's highest operating margin.
U.S. government spending trends are key drivers of GD's financial performance given that the company generates most of its revenues from the U.S. government, particularly from the Department of Defense (DoD).
U.S. defense spending has been on an upward trend for more than a decade, but the fiscal 2012 and fiscal 2013 budgets represent a turning point, with spending beginning to turn down in fiscal 2013, even excluding war spending, albeit from very high levels. The fiscal 2012 DoD base budget is up less than 1% compared to fiscal 2011, and the requested base budget for fiscal 2013 is down 1% to $525 billion. Fiscal 2013 Modernization Spending (procurement plus research and development [R&D]), the most relevant part of the budget for defense contractors, is down 4%, the third consecutive annual decline by Fitch's calculations.
The overhang of potential automatic cuts beginning in early 2013 related to the 'sequestration' situation, as well as the presidential election, add to the uncertainty faced by defense contractors in the current environment. The U.S. defense outlook will be uncertain and volatile over the next one to two years, and program details will be needed to evaluate the full effect on GD's credit profile.
On Sept. 14, 2012, the Office of Management and Budget issued a Sequestration Transparency Act report detailing the potential impact of sequestration on funding reductions for both defense and nondefense budget accounts. The report assessed that unless the sequestration law is changed, the DoD budget will be cut by approximately $52 billion in fiscal year (FY) 2013. Budget cuts to Modernization Spending would be expected to account for approximately $23 billion or nearly 44% of the cuts despite comprising only 29% of the total DoD budget. The majority of the remaining cuts will be in the Operations and Maintenance account. Should sequestration occur, the cuts in Modernization Spending could be partly mitigated by low outlay rates during the first year for the majority of Procurement and R&D programs.
The business jet sector remains weak overall, and Fitch expects only a modest recovery in 2012 from the depressed levels in 2011. This segment is at risk in the event of an economic downturn, and small jets would be most affected. Business jet deliveries fell 10.7% in 2011, bringing deliveries to 48.1% below 2008 shipments. While overall deliveries were down in 2011, the large and midsize segments did better, as most of the weakness was driven by the lower end of the market. Billings reflect this mix, and Fitch expects the segment's revenues and profits will decline less than the top line.
According to General Aviation Manufacturers Association, worldwide business jet deliveries increased by 13.1% during the first half of 2012. The increase in deliveries was driven by a strong second quarter, during which deliveries totaled 171 units, up from 132 units delivered in the second quarter of 2011, a nearly 30% increase. The strong second quarter performance offset first quarter's weak results during which total deliveries fell by 4.7% compared to the same period of the prior year. Fitch expects deliveries in 2012 will increase approximately 5%, and revenues should rise 5%-10% as the large segment will continue to outperform the overall market.
During the first nine months of 2012, GD's outfitted deliveries fell from 72 units to 57 units compared to the same period in 2011; however, its Aerospace revenues were up 22% due to increased green deliveries, including for the new G650 aircraft, which began in the fourth quarter of 2011. GD's overall green deliveries rose to 88 aircraft from 72 through September. GD recently completed the final stages of obtaining the certifications for the G650 and the G280 aircraft. Both planes are expected to be ready to enter into service later in 2012.
Fitch currently rates GD as follows:
--Issuer Default Rating (IDR) 'A';
--Senior unsecured debt 'A';
--Credit facilities 'A';
--Short-term IDR 'F1';
--Commercial paper 'F1'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
--'Corporate Rating Methodology', Aug. 8, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology
David Petu, CFA
One State Street Plaza
New York, NY 10004
Brian Bertsch, +1-212-908-0549 (New York)