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Ducommun Incorporated -- Moody's changes Ducommun outlook to stable; affirms B2 CFR

·16 min read

Rating Action: Moody's changes Ducommun outlook to stable; affirms B2 CFR

Global Credit Research - 21 Dec 2020

New York, December 21, 2020 -- Moody's Investors Service, ("Moody's") affirmed its ratings for Ducommun Incorporated ("Ducommun"), including the company's B2 Corporate Family Rating (CFR) and B2-PD Probability of Default Rating. Concurrently, Moody's also affirmed the B2 ratings on Ducommun's senior secured credit facilities. Moody's speculative grade liquidity (SGL) rating has been upgraded to SGL-2, from SGL-3. The rating outlook has been changed to stable from negative.

The outlook revision reflects expectations a more stable operating environment for commercial aerospace markets going forward as well as continued growth in defense end markets. This is expected to translate into moderate earnings growth and improved cash generation during 2021. The stable outlook also recognizes the gradual benefits that will accrue from the recent ungrounding of the 737MAX, a platform that has historically accounted for a significant share of Ducommun's commercial aerospace business.

RATINGS RATIONALE

The B2 CFR balances Ducommun's small size, exposure to cyclical end markets, and comparatively low margins against moderate levels of financial leverage, favorable growth prospects for its defense business, and a relatively well-positioned set of credit metrics.

Moody's recognizes Ducommun's content on a number of key commercial aerospace programs as well as its presence on a diverse and growing array of defense platforms. Moody's expects defense to be a key driver of earnings during 2021, driven by continued market share gains with defense contractors and the on-going growth of platforms such as the F-35, Black Hawk and various missile programs.

Notwithstanding the dual headwinds from the grounding of the MAX and the aftermath of the coronavirus pandemic, Ducommun's credit profile has remained comparatively healthy through the end of 2020. This was primarily due to strong organic growth in the company's space and defense segment (66% of YTD Sept 2020 sales), which largely offset the dramatic sales and earnings declines that Ducommun experienced in its commercial business (27% of sales). Moody's anticipates comparatively moderate levels of financial leverage for December 2020 with Moody's adjusted debt-to-EBITDA expected to be around 4.5x.

These considerations are tempered by Ducommun's relatively low levels of profitability (EBITDA margins around 13%) that result from a product portfolio that includes some low-value work, although we recognize the company's efforts to move up the value chain and the marked improvements in profitability over the last few years. The company's dependence on cyclical aerospace OEM markets that are prone to downturns and vulnerable to pricing pressure from large customers is an additional tempering rating consideration.

The spread of the coronavirus pandemic, the weakened global economy and outlook, low oil prices and asset price declines are sustaining a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The passenger airline industry is one of the sectors most significantly affected by the shock given its exposure to travel restrictions and sensitivity to consumer demand and sentiment. With demand for new passenger aircraft intricately linked to demand for air travel, production and deliveries of new aircraft will be materially lower than pre-coronavirus planned levels. Moody's regards the coronavirus pandemic as a social risk under its ESG framework, given the substantial implications for public health and safety.

The SGL-2 speculative grade liquidity rating denotes Moody's expectation of good liquidity over the next 12 months. Moody's expects free cash generation to be essentially flat in 2020 but anticipates improved cash generation in 2021 with free cash flow-to-debt in the low to mid-single-digits. External liquidity is provided by a $100 million revolving credit facility that expires in 2024. As of September 2020, $50 million of the facility was utilized. Absent near-term M&A activity, Moody's expects Ducommun to repay most of its revolver borrowings over the next few quarters, although Moody's anticipates periodic usage under the facility to support the funding of bolt-on acquisitions. The revolver contains a maintenance-based maximum total net leverage ratio of 4.75x, and Moody's expects the company to maintain adequate cushions relative to the covenant.

The stable outlook reflects expectations of continued growth in defense markets as well as a more stable operating environment for commercial aerospace going forward. This will likely translate into moderate earnings growth and improved cash generation during 2021. The stable outlook also recognizes the recent ungrounding of the 737MAX, which has historically been Ducommun's most important commercial aerospace platform.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Given Ducommun's comparatively modest size, Moody's expects the company to maintain credit metrics that are stronger than levels typically associated with companies at the same rating level. The ratings could be upgraded on expectations of a conservative financial policy with Moody's-adjusted debt-to-EBITDA expected to remain below 4.25x. Maintenance of a strong liquidity profile would be a prerequisite to an upgrade, with free cash flow-to-debt expected to remain in the mid-single-digits as a percent of sales coupled with substantial availability on the company's revolver. Strong operating performance across structures and electronics, robust levels of backlog and a larger scale with less reliance on OEMs and greater exposure to aftermarkets would also be supportive of an upgrade.

The ratings could be downgraded if Moody's-adjusted debt-to-EBITDA was expected to remain above 5.5x. A weakening liquidity profile involving free cash flow-to-debt consistently in the low single-digit range as a percent of sales and/or increased reliance on revolver borrowings, or expectations of non-compliance with financial covenants, would create downward ratings pressure. A deterioration in operating performance that led to a weakening of margins, the loss of a large customer, or unanticipated leveraging transactions either in the form of acquisitions or shareholder distributions could also result in a downgrade of ratings.

The following is a summary of today's rating actions:

Issuer: Ducommun Incorporated

Corporate Family Rating, affirmed B2

Probability of Default Rating, affirmed B2-PD

Senior secured credit facility, affirmed B2 (LGD3)

Speculative Grade Liquidity Rating, upgraded to SGL-2 from SGL-3

Outlook, Changed to Stable from Negative

Ducommun Incorporated (NYSE: DCO), headquartered in Santa Ana, California, is a provider of engineering and manufacturing services to aerospace, defense and industrial markets. The company operates two segments: Electronic Systems (60% of sales) and Structural Systems (40% of sales). Electronic Systems designs, engineers and manufactures electronic and electromechanical products such as cable assemblies and interconnect systems, printed circuit board assemblies and lighting diversion systems. Structural Systems designs, engineers and manufactures structural components and structural assemblies such as winglets, engine components and fuselage structural panels. Revenues for the twelve months ended September 2020 were almost $660 million.

The principal methodology used in these ratings was Aerospace and Defense Methodology published in July 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1224306. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Eoin Roche VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Russell Solomon Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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