oWe are assigning our 'BBB+' long-term issuer credit rating to Safran SA, a France-based leading tier 1 manufacturer of aerospace propulsion systems, aircraft equipment and aircraft interiors.
oThe 'BBB+' rating primarily reflects Safran's strong balance sheet, conservative finanical policy, and strong cash generation profile, supported by relatively resilient profit margins; as well as its significant exposure to the commerical aerospace sector that is undergoing a significant downturn due to the COVID-19 pandemic.
oDespite the pandemic and thanks to management's swift actions to preserve profitability and cash flow, we forecast that the company will maintain EBITDA margins of above 15% over 2021-2022 and generate free operating cash flow (FOCF) of close to EUR1 billion in 2021 and EUR1.0 billion-EUR1.5 billion in 2022, compared with about EUR1.4 billion in 2020 and about EUR2.3 billion in 2019.
oThe stable outlook reflects our expectation that Safran's cost-cutting measures and discipline on investments will translate into funds from operations (FFO) to debt of at least 40% and FOCF to debt at above 20% in 2021, despite air traffic demand not recovering to 2019 levels until at least 2024.
PARIS (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above. Safran is well positioned to steer through the worst aerospace downturn in the industry's history, thanks to its strong balance sheet and strong cash generation profile, and supported by resilient profit margins. In our global air passenger traffic forecast (for more information, see "Industry Top Trends 2021: Aerospace and Defense: Pandemic Will Pressure Commercial Aerospace Through At Least 2021," published Dec. 10, 2020, on RatingsDirect), we expect air passenger traffic to decline 40%-60% in 2021 compared with 2019 levels, and foresee a gradual recovery to pre-pandemic levels only by 2024. Safran's customers, such as airlines, are reducing their fleets to cope with the lower demand, while aircraft original equipment manufacturers Airbus and Boeing have cut their production rates by 30%-50% on most models, with the deepest cuts to wide-body production. Safran, however, is present on narrow-body airplane platforms that service domestic and regional air travel and are expected to recover more quickly than wide-body aircraft and international air traffic. This contrasts quite strongly with key peer Rolls-Royce PLC, which is only present on wide-body aircraft.
For Safran, the pandemic's effects will translate into lower engine sales and subdued demand for aftermarket services compared with the industry peak in 2019. The company's propulsion division is its main profit source, thanks to its larger share of higher-margin service (repairs and spare parts) revenue. In 2020, services revenue accounted for about 61% of propulsion engines revenue; this was 44% for the group overall.Therefore, the recovery in aftermarket activities will be key to restoring higher operating profits. In 2020, Safran's sales declined by about 33% primarily due to the slump in air traffic and airplane demand that affected all divisions. Nevertheless, the company maintained an S&P Global Ratings-adjusted EBITDA margin at about 14% in 2020 versus about 18% in 2019, and we expect that Safran's EBITDA margin will stay above 15% for the 2021-2022 period, toward the higher end of the average (10%-18%) range for the aerospace sector. This reflects the company's agility in reducing operating costs through layoffs (with a 21% workforce reduction in 2020, including temporary staff) and the flexible work agreement negotiated with French unions that is in effect until the end of 2021. The resilience in earnings despite the weak demand, coupled with a strict discipline on capital expenditure (capex), should support strong FOCF.
With a low debt-to-EBITDA ratio of about 1.3x and a solid FOCF-to-debt ratio of about 38% in 2019, Safran exhibited a strong balance sheet before the pandemic, refecting the companay's strong cash generation profile and conservative financial policy. This also contrasted strongly against some aerospace peers (such as Boeing, Spirit Aero, and Rolls-Royce) who, when the pandemic first hit, were already grappling with engineering challenges and pressured profitability, weaker cash flow, and rising debt levels. We expect the group's debt-to-EBITDA ratio to gradually decline below 1.5x by 2022 from a peak of 2.0x in 2020 due to the pandemic.
Thanks to its positioning on narrow-body aircraft and the young age of its installed engine fleet, Safran is well positioned to ride out the downturn. Through its 50-50 joint venture with General Electric, Safran is the market leader for propulsion engines in short- and medium-range aircraft ahead of its American competitor Pratt & Whitney (part of Raytheon Technologies Corp. [RTC]). We believe that domestic air travel is likely to recover before international, so narrow-body production could begin to increase in late 2021 if demand warrants. As air travel increases, aircraft will require more repairs and spare parts. The retirement of older aircraft could hinder recovery in higher-margin spare parts sales. This is because those older aircraft generally require more maintenance and, when scrapped, will be a source of used parts that compete with new ones. Nevertheless, we think the company is less likely to feel the effects, thanks to the young age of its CFM56-5B/7B installed fleet. In 2020, about 50% of these engines had not gone through their first shop visits yet which usually occur after six-to-seven years of service. For these reasons, we have modeled a marked recovery in aftermarket services in 2022 that should support FOCF of EUR1.0 billion-EUR1.5 billion in 2022. We also believe that Safran's lower reliance on fly-by-the-hour contracts compared with that of some peers such as Rolls-Royce is an advantage in downturns, because its cash flow profile is somewhat less affected by sudden fall in the number of flying hours.
Safran's positive discretionary cash flow will support deleveraging such that by 2022, its credit metrics will get closer to 2019 levels. After suspending the dividend payment of about EUR1 billion in 2020, Safran's management will propose a dividend payment of EUR184 million in 2021. For 2022, we assume that the company will make dividend payments with a payout ratio of about 40%. We have not included any acquisitions in our base-case scenario because we believe management will focus on deleveraging its balance sheet toward 2019 levels.
Safran's limited diversifcation outside the commerical aerospace sector is a constraining factor for our assessment of the group's business risk profile relative to that of peers. About 75% of the company's activities relate to commercial aerospace, a sector that is heavily affected by the COVID-19 pandemic. Defense and helicopters related operations make up the remaining 25%. Within commercial aerospace, Safran offers a very broad range of products covering extensive functions of an aircraft (such as engines, nacelles, brakes, wheels, fluid systems, cabins, seats, lavatories). However, we think that Safran lags the diversity of peers such as Thales, RTC, or BAE Systems, and which are likely to demonstrate more resilient revenue, EBITDA and cash flow in 2020-2021. For instance, France-based engineering company Thales covers diverse end markets, including transportation, commercial aerospace, defense and digital security. U.S.-based RTC was formed from the merger between UTC technologies and Raytheon; it is one of the largest aerospace and defense companies. Its revenue profile is more balanced than Safran's, with 55%-65% of sales correlated to commercial aerospace and 35%-45% of sales related to defense. Finally, although BAE Systems is a pure defense player, it exhibits a large diversity of programs being on air, marine, and field platforms. In our base-case scenario for 2020, we expect revenue for Thales to drop by just 7%-7.5%; while RTC's sales declined by about 23% organically compared with the 33% drop for Safran.
The stable outlook reflects our expectation that Safran's cost-cutting measures and discipline on investments will translate into an adjusted FFO-to-debt ratio of at least 40% and an adjusted FOCF-to-debt ratio of above 20% in 2021 despite air traffic demand remaining low (40%-60% below 2019 levels). We also factor in a marked recovery of those ratios to above 60% and 30%, respectively, in 2022.
We could lower our ratings if we were to expect that Safran failed to sustain the following key credit metrics:
oAdjusted FFO to debt above 45%
oAdjusted FOCF to debt above 20%
This could occur in case of operating missteps or if Safran cannot reduce its costs to match slower than expected recovery in air traffic. Although not expected, it could also result from a more aggressive financial policy.
We could raise our ratings on Safran if the company sustainably strengthens its credit metrics, such that:
oAdjusted FFO to debt stays above 60%; and
oAdjusted FOCF to debt is consistently higher than 40%.
This would also require that Safran maintains EBITDA margin of 16%-18% as well as a conservative financial policy.
oCriteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
oGeneral Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
oCriteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
oCriteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
oGeneral Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
oGeneral Criteria: Methodology: Industry Risk, Nov. 19, 2013
oGeneral Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
oGeneral Criteria: Principles Of Credit Ratings, Feb. 16, 2011
oIndustry Top Trends 2021: Aerospace and Defense, Dec. 10, 2020
oAirbus SE, Nov. 12, 2020
oRaytheon Technologies Corp. Nov. 6, 2020
oRolls-Royce PLC Downgraded To 'BB-' And Placed On CreditWatch Negative, Sept. 11, 2020
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