Rating Action: Moody's affirms Thales' Senior Unsecured rating at A2; outlook negative
Global Credit Research - 17 Aug 2020
Frankfurt am Main, August 17, 2020 -- Moody's Investors Service, ("Moody's") has today affirmed Thales' senior unsecured and short term ratings at A2 and P-1 respectively. The outlook has been changed to negative from stable.
A full list of affected ratings can be found at the end of the press release.
The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The aerospace and defense sector has been one of the sectors most significantly affected by the shock given its exposure to commercial aviation and the impact of sanitary measures and lockdowns on the profitability of the more resilient defense activities. More specifically, Thales' credit profile with its exposure to most airline customers across the world has left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and Thales remains vulnerable to the outbreak continuing to spread. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. Today's action reflects the impact on Thales of the breadth and severity of the shock, and the deterioration in credit quality it has triggered.
The rating affirmation considers Thales' good revenue and backlog diversification as a strong mitigant to the severity of the demand shock from the outbreak on its activities directly exposed to the commercial aviation sector (around 11% of group revenues in 2019), as well as the expectation of a performance turnaround in 2021. Furthermore, the affirmation reflects the company's proactive operational and financial measures implemented to mitigate the impact of the current market disruptions.
Thales' performance in the first half of 2020 was severely impacted by coronavirus related disruptions. Demand in civil aeronautics (around 11% of 2019 revenue) dropped by more than 50% in the second quarter and sanitary measures materially reduced productivity for its more resilient defense operations resulting in a 57% year-on-year reduction in the company's reported EBIT in the first half of 2020. Moody's expects revenue in civil aeronautics to be around 50% lower than prior year in the second half of 2020 and to recover to 2019 levels in 2023 at the earliest due to lower OEMs' production rates. In contrast, profitability at the group level is expected to recover in the second half of 2020 as productivity will reach normal levels after lockdown disruptions in H1 and will also be supported by around E450 million cost saving measures. In addition, the company's exposure to the more resilient defence market (45% of 2019 revenue and more than 64% of 2019 backlog) and digital identity and security (14% and 2%) will mitigate the negative impact of civil aeronautics in 2020 and further support the recovery of operating performance from 2021.
Moody's base case assumes that in 2020 revenue and operating profit margin will decline by 7 and 2 percentage points respectively in comparison to 2019 levels due to the sharp drop in civil aeronautics' revenue and lower productivity in the first half of 2020. Moody's expects that operating performance will progressively improve from 2021 supported by mid-single digit topline growth and recovery in profitability to 2019 levels by 2022. Moody's-adjusted free cash flow (FCF) are expected to remain positive through 2022 supporting the repayment of upcoming debt maturities. Under this scenario Thales' leverage as measured by Moody's adjusted Debt/EBITDA will be around 5.8x in 2020, significantly exceeding Moody's downgrade trigger, before reverting back to around 3.4x by year-end 2022, closer to Moody's tolerance level for the current rating. These expectations remain subject to material uncertainty including the risk of further lockdowns or productivity issues in H2 2020, prompting the change of the outlook to negative.
More broadly Thales' A2 senior unsecured rating reflects (1) the company's leading global and European market positions and the high-technological nature of its businesses; (2) the good revenue and backlog diversification as well as the exposure to higher-growth markets; (3) conservative financial policies, which afford flexibility to manage seasonal working capital swings and longer-term business cyclicality.
At the same time the rating is constrained by (1) increasingly dynamic competitive landscape; (2) lower profitability in comparison to similarly rated industry peers; (3) elevated gross leverage for a baa1 baseline credit assessment (BCA); (4) continued uncertainties related to the outbreak of coronavirus including supply chain disruption and delays in contract execution.
Thales (A2 negative) is a government-related issuer (GRI) effectively controlled by the French state. It is 26% owned by the Government of France (Aa2 stable) (36% voting rights) via its state-owned entity, TSA. Thales' A2 rating incorporates a two-notch uplift applied to the company's stand-alone baa1 BCA, reflecting strong implicit support from the French state, and moderate default dependence.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook reflects Moody's expectation that Thales' key credit metrics will be weak for the current rating and will recover to level more commensurate with the baa1 BCA by 2022. The outlook also reflects the uncertainties related to the length of the current outbreak and the recovery pattern of demand for aircrafts post outbreak.
Thales' liquidity is deemed very strong. The company had around E6.6 billion total available liquidity as of 30 June 2020, including E3.8 billion of cash on balance sheet and E2.8 billion committed credit lines (increased from E1.5 billion available as of December 2019). Thales has also access to a E2 billion commercial paper program. This is more than enough to cover basic cash needs, including the payment of upcoming debt maturities and the sizable swings in working capital reflecting the volatility in payments on big defence contracts.
Liquidity is further supported by the company's strong track record in generating meaningful FCF. Moody's expects that Thales will continue to generate positive Moody's adjusted FCF consistently through 2022.
The revolving credit facility is subject to a financial covenant -- consolidated net debt/EBITDA below 3.0x -- but only if the French government no longer holds a golden share. Moody's considers this a highly unlikely scenario, but in the event the French government does relinquish its golden share, Thales would be comfortably in compliance considering its current net cash position on a reported basis.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Positive rating pressure is unlikely in the short term. Longer term an operating margin in at least the low double-digit, a gross leverage as measured by Moody's-adjusted debt/EBITDA below 2.5x and excellent liquidity position could lead to positive rating pressure.
Negative rating pressure would build if Moody's-adjusted debt/EBITDA would increase sustainably above 3.25x, especially if not sufficiently balanced by the company's cash. A decline in operating margins back towards the mid-single digits in percentage terms, as well as less solid free cash flow (FCF/Debt sustainably below 5%) resulting in a weaker liquidity profile could also lead to negative rating pressure.
The methodologies used in these ratings were Aerospace and Defense Methodology published in July 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1224306, and Government-Related Issuers Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
LIST OF AFFECTED RATINGS: Affirmations: ..Issuer: Thales
....Commercial Paper, Affirmed P-1
....Senior Unsecured Medium-Term Note Program, Affirmed (P)A2
....Other Short Term, Affirmed (P)P-1
....Senior Unsecured Regular Bond/Debenture, Affirmed A2
....Outlook, Changed To Negative From Stable
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_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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.
Stanislas Duquesnoy Senior Vice President Corporate Finance Group Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Matthias Hellstern MD - Corporate Finance Corporate Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
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