Fitch Affirms Orbital ATK's Ratings; Outlook Stable
Fitch has also affirmed the ratings for OA's senior secured facilities and senior unsecured notes. Fitch's ratings currently cover approximately \\$1.6 billion long term debt. Fitch has withdrawn the ratings for ATK's senior subordinated notes following their repayment in connection with the spin-off. The Rating Outlook is Stable. The company's full rating list follows at the end of this release.
In accordance with its updated Recovery Rating (RR) methodology, Fitch is now providing RRs to issuers with IDRs in the 'BB' category. Fitch has assigned an 'RR1' to OA's senior secured facilities and an 'RR4' to the company's senior unsecured debt. The 'RR'1 for the senior secured facilities reflects an estimate of outstanding recovery prospects (91-100%) in a distressed scenario. The 'RR4' for OA's senior unsecured debt supports a rating of 'BB+', the same as OA's IDR, and reflects estimated average recovery prospects (31-50%) in a distressed scenario.
VSTO accounted for approximately \\$2.3 billion (about 40%) of pre-spin-off ATK's pro forma fiscal 2015 (ending March) revenues and approximately 45% of ATK's combined EBITDA and FCF. In connection with the spin-off, Fitch estimates OA received a one-time dividend from VSTO in the range of \\$200 million to \\$240 million. The majority of the cash was utilized to redeem \\$350 million of senior subordinated notes.
ORB shareholders received ATK shares as a part of the merger and the surviving entity (ATK) was renamed OA effective Feb.
9, 2015. As a part of the merger, ORB's outstanding debt was retired and OA retained ATK's existing senior secured credit facilities and senior unsecured obligations.
KEY RATING DRIVERS
The ratings and Stable Outlook are supported by OA's solid margins and strong cash flows, good product/program diversification, significant cost saving synergy opportunities from the merger, and OA's role as a sole source provider for many of its products. The ratings are also supported by adequate financial flexibility and Fitch's expectations that OA will improve its credit metrics by fiscal 2017 driven by improvements in operating performance and scheduled debt reduction.
Some of OA's leverage metrics are weak for the ratings and have deteriorated slightly following the VSTO spin-off and the merger despite retiring ATK's \\$350 million senior subordinated notes. Fitch estimates OA's leverage (debt to EBITDA) and adjusted leverage (adjusted debt / EBITDAR) will be 3.0x and 3.6x, respectively, nearly unchanged from the ATK's 2.9x and 3.4x at the end of fiscal 2014. Pro forma fiscal 2015 FFO adjusted leverage is expected to deteriorate notably to 4.6x, up from 3.8x at the end of fiscal 2014, due to lower funds from operations as stand-alone ORB generated lower revenues and margins than spun-off VSTO.
Fitch estimates OA's credit metrics will improve over the next two years driven by modest revenue growth, marginal operating improvements and scheduled repayment of the company's term loans. Fitch expects OA's leverage and adjusted leverage will decline to 2.4x and 3.0x, respectively, by the end of fiscal 2017. FFO adjusted leverage is also expected to improve to 3.9x during the same time frame. Other metrics such as FCF margin and FFO fixed charge coverage are solid for the ratings.
Fitch is concerned with merger integration risk, rising competition in some space sectors, a continued decline in small caliber ammunition demand and lower contract rates which resulted from the renewal of the Lake City operating contract in fiscal 2013, and lower modernization activities at Lake City. Additionally, VSTO's spin-off and the subsequent merger with ORB significantly increased the company's exposure to the U.S. Government, which now accounts for approximately 74% of total revenues. Fitch will monitor OA's cash deployment strategies, but expects the company's share repurchases and dividends will be moderate. Fitch anticipates OA's acquisition activities will also be moderate.
Fitch will monitor the ongoing investigation of the recent explosion of ORB's Antares Rocket while carrying approximately 5,000 pounds of supplies to the International Space Station as part of Orbital's \\$1.9 billion contract with NASA. Fitch is concerned with the potential operating distractions associated with the decision to accelerate to 2016 the replacement of AJ26 engines with RD-181 engines. Additionally, Fitch expects there may be operating margin compression if OA uses third-party rockets to fulfill its contract with NASA. The contract accounted for 24% of ORB's revenues in 2013 and 2012.
Fitch is also concerned with the \\$562 million underfunded status of ATK's legacy pension (81% funded as of the end of fiscal 2014). OA retained the majority of legacy ATK's pension liabilities and will continue making significant cash pension contributions. ORB's legacy defined benefit pension plan liabilities are not material and are fully funded.
Fitch expects the underfunded portion of the pension liabilities to increase significantly in fiscal 2015 driven by new mortality tables and adverse movements in the prevailing interest rates. The pension obligation totaled approximately \\$3 billion at the end of fiscal 2014. Other post-employment benefit (OPEB) obligations totaled \\$128 million and were \\$67 million underfunded. ATK contributed \\$40 million to its defined benefit plans in fiscal 2014. During the nine months ended December 28, 2014, ATK contributed the minimum required contribution of \\$80 million to its defined benefit plans, and it does not expect to make additional contributions in fiscal 2015.
OA has adequate financial flexibility for the ratings. Fitch expects the company's liquidity will be approximately \\$670 million at the end of fiscal 2015 consisting of approximately \\$370 million in cash and \\$300 million of availability under its \\$700 million revolving credit facility (after giving effect to the expected revolver draw and outstanding letters of credit). Fitch expects OA's liquidity will improve as the company reduces its short term borrowings under the revolving credit facility over the next several years. Additionally, Fitch expects the company will generate more than \\$250 million of FCF (before dividends) annually, affording OA additional financial flexibility and the ability to de-lever.
The notching up of the senior secured credit facility by one rating level from the IDR of 'BB+' to 'BBB-' is supported by the coverage provided by OA's tangible assets and operating EBITDA compared to the fully drawn facility. The collateral for the facility includes substantially all of OA's assets.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
--Low single digit revenue growth.
- Lower overall EBITDA margins at approximately 13% immediately following the merger.
--EBITDA margins will increase to approximately 14% at the end of fiscal 2017, reflecting Fitch's conservative view of the realized merger synergies.
--Identified synergies were modeled only partially resulting in margin improvements slower than company forecasts.
--Debt repayment will be gradual and based on term loan repayment schedules.
--Revolving debt is expected to remain outstanding for the next three years with \\$50 million of annual repayment during the first two years.
--The company will reduce the per share dividend payout: annual payments will be in the range of \\$35 million to \\$45 million over the next three years.
--OA will resume share repurchases in the range of \\$50 million to \\$75 million over the next three years.
--Cash flow generation will be positive and the company will generate above \\$200 million of FCF annually.
--Capital expenditures will fluctuate in the range of 2.4% to 3% of revenues, annually.
--OA is not expected to make sizable acquisitions in the near future.
RATING SENSITIVITIES
Fitch does not expect to take positive rating actions over the next several years until OA reduces its leverage and successfully completes the merger integration. A positive rating action will also depend on the clarity of the company's future financial policies and cash deployment strategy.
Fitch may take a negative rating action if the company's leverage and adjusted leverage remain above 3.0x and 3.5x for a prolonged and sustained period of time. Fitch may also consider a negative rating action if the company's FFO adjusted leverage remains above 4.25x by the end of fiscal 2016 or if FCF margin declines and remains below 3%.
Additionally, a negative rating action may be considered if the merger results in unforeseen operating challenges and the company fails to achieve expected financial results, or if the company engages in sizable share repurchases prior to reducing leverage.
Fitch has affirmed OA's ratings as follows:
--Long-term IDR at 'BB+';
--Senior secured bank facility at 'BBB-'.
--Senior unsecured notes at 'BB+'
Fitch has assigned OA the following ratings:
--Senior secured bank facility 'RR1'.
--Senior unsecured notes 'RR4'
The Rating Outlook is Stable.
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