OREANDA-NEWS. Fitch Ratings has assigned an 'A' rating to General Dynamics Corporation's (GD) issuance of $1 billion of senior unsecured notes.

The company intends to use the proceeds to replenish cash utilized to retire $500 million of senior unsecured notes that matured in July 2016. The remaining $500 million will be used for general corporate purposes, including share repurchases. Fitch's ratings for GD will cover approximately $4 billion of debt after giving effect to the announced debt issuance.

The Rating Outlook is Stable. A full list of ratings appears at the end of this release.

KEY RATING DRIVERS

The company's ratings are supported by solid credit metrics, strong free cash flow (FCF; cash from operations less capital expenditures and dividends), financial flexibility and strong liquidity position, competitive positions in business jets and defense, and large backlog. Another positive factor is the level of diversity in GD's portfolio of products and services, both domestically and internationally, including military and commercial ship building, ground combat systems and business jets.

GD's credit metrics will remain strong for the ratings, after giving effect to the announced issuance of the incremental $500 million senior unsecured notes. The new $1 billion issuance will effectively replace $500 million of senior notes repaid in July 2016 as well as $500 million of senior notes that were repaid in January of 2015. Fitch projects that gross leverage (debt/EBITDA) and adjusted leverage (adjusted debt/EBITDAR) will increase slightly to 0.8x and 1.2x, respectively, at the end of 2016, up from 0.7x and 1.1x at the end of the prior year. However, these ratios still reflect improvement from levels reported between 2011 and 2014 when leverage averaged 0.9x.

GD has a conservative financial profile and an effective operating strategy that helped the company maintain a strong credit profile through the most recent downturn in the business jet sector and sizable reductions in the U. S. military spending. Over the past several years, the company has achieved significant operating improvements as evidenced by a meaningful increase in EBITDA margins to 15.2% in 2015, up from 11.3% in 2011. The company has adequate financial flexibility bolstered by good liquidity, manageable capital expenditures in the range of 1.5% to 1.8% of sales and sizable annual FCF.

GD's pre-dividend FCF is typically higher than its net income; however, cash conversion fell to approximately 65% in 2015 because of higher capital expenditures, a build-up of inventory in the Aerospace segment and working off the large advanced payments received in 2014 on a major program in the Combat segment and at NASSCO for commercial shipbuilding programs. Fitch expects cash conversion will be at approximately 70% in 2016 as the company will continue building inventory for the G500 and G600 programs and working off the advance payments. Fitch also anticipates GD's cash conversion will increase to historical levels beginning in 2017 driven by the completion of Jones Act ships and an increase in cash flows associated with the full-rate production of several international orders in the Combat segment. Future cash flows should also be aided by the expected deliveries of the new G500 and G600 aircraft in 2018 and 2019.

The company generated $1.9 billion of pre-dividend FCF in 2015, down from $3.2 billion in 2014. Fitch expects GD will generate approximately $2 billion of pre-dividend FCF in 2016 and annual pre-dividend FCF in the range of $3 billion to $3.2 billion 2017 and beyond. Despite lower FCF in 2015, the company continued to deploy cash towards shareholders as it paid $873 million in dividends and repurchased approximately $3 billion shares. Fitch expects the company will continue steadily increasing dividend payments, which are estimated to fluctuate in the range of $900 million to $1 billion over the next two years, and will repurchase approximately $2 billion shares annually.

While Fitch is concerned by the aggressive cash deployment towards the shareholders, this concern is mitigated by conservative financial policies of the company's management. During the recent downturn, the company built sizable cash balances by significantly reducing its share repurchases in 2012 and 2013 in response to a slowdown in the business jet market and the U. S. budgetary pressures.

Fitch is also concerned by the uncertainty of the timing of international orders and GD's exposure to possible declines in core U. S. defense spending. The company is exposed to changes in the U. S. Navy shipbuilding plans as its Marine Systems segment derives a significant portion of its revenues from building Virginia class submarines and the Arleigh Burke-class guided missile destroyers. A dramatic unexpected change in U. S. defense spending policies would be a key driver of GD's credit profile, although Fitch believes that modest declines in defense spending would not necessarily lead to negative rating actions given GD's current credit metrics, liquidity position, and diversified product portfolio.

There is an execution risk of successfully delivering the two new large-cabin business jets announced in 2014 (the G500, and the G600). The demand for these new models has been robust since the announcement, but it has negatively impacted the demand and sales of the G450 and G550 models. As a result, Fitch anticipates lower revenues in the Aerospace segment over the next several years. Despite top line challenges, GD has achieved meaningful margin improvements it the segment due to cost savings initiatives and improved operating performance. Fitch's concerns are somewhat mitigated by a significant backlog for the G650 and the G650ER aircraft as the company has indicated it has flexibility to pull forward production for these aircraft and fill-in a possible production void should the demand for the G450 and the G550 fall dramatically.

GD has a sizable pension deficit somewhat mitigated by GD's strong cash generation. The company's defined benefit pension obligations totaled $12.5 billion and were 68% funded ($3.9 billion underfunded) at the end of 2015. Even though GD's total pension obligation decreased by approximately $680 million in 2015, the underfunded status remained unchanged at 68% from the prior year. Despite the unchanged underfunded status of the pension liabilities, the company's minimum required contributions declined significantly in 2015 due to the beneficial impact from the passage of the Highway and Transportation Funding Act of 2014 (HATFA). GD contributed $187 million towards its pension plans in 2015, down from $550 million in 2014. The company plans to contribute approximately $200 million to the pension plans in 2016, and Fitch believes cash contributions will not have a significant effect on the company's cash deployment strategy in the near future.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for GD include:

--Flat sales in 2016 and low single digit annual revenue growth beginning in 2017;

--Steady EBITDA margins in the range of 14.5% to 15.5%;

--Combined net share repurchases and dividend payments will be above $2.5 billion annually and will roughly equal to the company's net income.

--Similar to 2015 results, post dividend FCF margins will be in the range of 3.5% to 4% in 2016. FCF margins will rebound beginning in 2017 and will be in the range of 6% to 7%;

--Capital expenditures will remain steady in the range of 1.7% to 1.8% of revenues;

--Debt maturities will be refinanced and leverage will remain constant;

--Share repurchases will be reduced if the company makes material acquisitions;

--Pension contributions will not be a significant portion of the company's cash deployment in the near future.

RATING SENSITIVITIES

Fitch would consider a negative rating action if the company's leverage (debt / EBITDA) or FFO adjusted leverage deteriorate and remain worse than the ranges of 1.3x to 1.5x and 2.1x to 2.3x, respectively, driven by a cancelation of key programs, a significant downturn in the business jet sector, or unsuccessful attempts to reduce costs in line with potential revenue reductions. Fitch believes the company has significant financial flexibility, and its credit metrics could sustain moderate deterioration without pressuring the current ratings.

A positive rating action is unlikely in the near term due to the Aerospace Segment's cyclical nature and some uncertainty in the U. S. defense spending outlook and its impact on the IS&T segment. Fitch may consider a positive rating action if the company modifies its cash deployment strategy which currently targets a return of 100% of net income to shareholders in the form of share repurchases and dividends.

LIQUIDITY

As of June 30, 2016, GD maintained approximately $3.9 billion total liquidity consisting of $1.9 billion in cash and full availability under its $2 billion revolving credit facility. The company maintained significantly higher liquidity during the past five years to mitigate increased uncertainties in the U. S. DoD spending and a severe downturn in the business jet markets. GD's liquidity reached as high as $7.3 billion at the end of 2013 and has been decreasing since a result of share repurchases and dividends. Fitch expects the company's liquidity to remain at approximately $4 billion over the rating horizon.

GD's debt structure consists of senior unsecured notes denominated in U. S. dollars. The issuer of the bulk of the debt is the parent company, and the notes are guaranteed by subsidiaries accounting for approximately 87% of revenues in 2015. The non-guarantor entities are principally foreign subsidiaries. The next large maturity is in November 2017 when a total of $900 million senior unsecured notes are due. Fitch believes the company will be able to repay these notes with cash on hand, but refinancing is more likely as Fitch expects the company will maintain its current leverage.

FULL LIST OF RATING ACTIONS

Fitch rates General Dynamics Corporation as follows:

General Dynamics Corporation

--Issuer Default Rating (IDR) 'A';

--Senior unsecured debt 'A';

--Credit facilities 'A';

--Short-term IDR 'F1';

--Commercial paper 'F1'.

Rating Outlook is Stable.