OREANDA-NEWS. Fitch Ratings has affirmed Bombardier Inc.'s (BBD) Issuer Default Rating (IDR) at 'B' and long-term debt and bank facility ratings at 'B'/'RR4'. Fitch has reviewed the ratings in light of BBD's announcements last week regarding worse-than-expected negative free cash flow (FCF), planned equity issuance, and large impairment charges.

The Rating Outlook is Negative. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The affirmation incorporates Fitch's assumption that BBD will complete the sale of a stake in the CSeries program for $1 billion to the government of Quebec, with proceeds to be received during the second quarter of 2016 (2Q16). BBD could further boost liquidity as a result of its plans to place a minority stake in Bombardier Transportation (BT) in the near term which Fitch believes could raise $1 billion or more in cash, possibly as early as the 1Q16.

Fitch believes these actions are needed in order to support BBD's liquidity during a prolonged period of negative FCF that has deteriorated more quickly than anticipated by Fitch. Without the new sources of cash contemplated by BBD, Fitch could consider a downgrade of BBD's ratings due to concerns about negative FCF through the next several years related to spending on aircraft programs and production ramp-ups for the CSeries and Global 7000 and 8000 programs.

Fitch estimates FCF for all of 2015 could be as much as negative $2.3 billion, including a modest level of positive FCF in the fourth quarter. Much of BBD's cash usage in 2015 is due to a reduction in customer advances for business jets that negatively affected working capital. The impact on working capital should diminish substantially in 2016 but Fitch expects FCF could be almost $1 billion negative in 2016 and could be significantly negative, although at lower levels, at least through 2018 when BBD's next debt maturities occur.

The expected $1 billion investment in the CSeries program by the government of Quebec would help complete development of the CSeries and fund production losses which could continue through the next four years as the program moves down the learning curve. In addition, the planned placement of a minority stake in BT would further supplement BBD's cash position while BBD develops the Global 7000 business jet expected to enter into service in the second half of 2018. If the BT minority stake is not completed, Fitch believes BBD's cash balances could drop below $2 billion sometime in 2017 or early 2018. This level provides a cushion against short term peaks in cash requirements related to aircraft programs.

BBD recognized two large non-cash charges totaling $4.4 billion in the 3Q15. A $3.1 billion impairment charge, together with other smaller provisions, was used to write down more than half of the company's investment in the CSeries, effectively recognizing cost overruns and diminished sales prospects compared to original expectations. BBD also cancelled the previously paused Learjet 85 program due to weak demand, resulting in a $1.2 billion charge.

Other concerns include BBD's high leverage, competitive pressure in each of the company's segments, and the risk of CSeries cancellations. BBD's high leverage includes debt/EBITDA of 8x at Sept. 30, 2015, which Fitch anticipates will increase due to negative margins associated with early production of the CSeries.

Contingent liabilities include residual value guarantees. In the 3Q15, BBD recognized a charge of $353 million to increase its provision for residual value guarantees. The charge reflected the weak market for used regional aircraft which increases the risk that some guarantees will be exercised.

BBD's bank facilities contain various leverage and liquidity requirements for both BBD, including Bombardier Aerospace (BA), and BT. Minimum required liquidity at the end of each quarter is $750 million for the BBD facility and EUR600 million at BT. BBD does not publicly disclose required levels for other covenants but there is a risk that weaker than expected operating results or an increase in debt could result in noncompliance. The lowest levels of covenant compliance typically occur in the middle of the year instead of at year-end because of BBD's cash flow profile.

Fitch views BBD's strong position in the global business jet market as a rating strength. In addition, there is upside potential to business jet margins due to the company's new management team which could bring a sharper strategic focus and improved operating results. In the near term, however, margins will be pressured by a decline in year-to-date orders that reflect lower sales to fleet customers and BBD's exposure to emerging markets where demand growth is slowing. BBD is cutting production of its Global 5000/6000 aircraft to around 50 units from 80 units sold in 2014. Fitch notes that gross orders in 3Q15 were solid, particularly as they were concentrated among traditional customers as compared to large orders prior to 2015 that were concentrated among fleet customers.

Fitch believes BBD's Global jets are responsible for the majority of profits in the Business Aircraft segment, so any weakening of industry demand for large jets or in BBD's market position could hinder the company's profitability and cash flow.

Although BBD is among the global market leaders for regional aircraft including regional jets and turboprops, the segment is a smaller contributor to BBD's overall profitability than business jets. Net orders for regional jets were low through the first three quarters of 2015 and the backlog is at the lowest level in several years. BBD expects to report EBIT of negative $200 million in 2015 in its commercial aircraft segment, including regional aircraft and the CSeries, which Fitch expects could increase as CSeries production ramps up further.

At BT, low margins reflect project complexity and a highly competitive industry. Margins could improve slightly in 2015, and Fitch expects the ongoing review by BBD's senior management could lead to further growth in margins, although the pace of improvement could be gradual. BT is taking actions to standardize operations across a relatively decentralized business and is focusing on higher-margin services and systems revenue. BT has much lower capital requirements than BBD's aerospace businesses and generates more stable FCF, but the timing of BT's FCF can vary between quarters due to the nature of its contracts.

BT has strong positions in its rail markets, particularly in Europe which represents BT's largest market. The competitive landscape is evolving, however, including several mergers and acquisitions among Asian and European equipment manufacturers. These transactions could exacerbate pricing pressure across the industry and make it more challenging for BT to build stronger margins, which remain below its long-term goal of 8%. BBD's planned IPO or private placement of a minority stake in BT could provide flexibility to consider arrangements such as joint ventures or M&A transactions that may strengthen BT's industry position and increase access to emerging markets which will be important to its long-term competitiveness.

Rating concerns are mitigated by BBD's diversification and market positions in the aerospace and transportation businesses and a portfolio of commercial aircraft and large business jets which the company has continued to refresh. The company's order backlog at Sept. 30, 2015 totaled $62 billion, roughly three times annual sales.

The Recovery Rating (RR) of '4' for BBD's senior unsecured debt and bank credit facility supports a rating of 'B' and reflects expectations of average recovery prospects (31%-50%) in a distressed scenario. It is based on Fitch's going-concern analysis of BBD that incorporates the company's established market positions and backlogs at both the aerospace and transportation businesses. The RR '6' for subordinated convertible debt and preferred stock reflects a low priority position relative to BBD's debt.

KEY ASSUMPTIONS

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

--The $1 billion investment in the CSeries by the government of Quebec is completed by the beginning of 2016;
--BBD places a minority interest in BT for at least $1 billion by sometime in the first part of 2016.
--Negative FCF of approximately $2.3 billion in 2015 and approximately $1 billion in 2016;
--Lower orders for large business jets lead to a decline in aerospace deliveries and margins in 2016;
--CSeries entry-into-service occurs in the first half of 2016;
--The commercial aircraft segment experiences lower margins due expected production losses on the CSeries;
--Development spending for the CSeries declines in 2016, offset by production losses and spending for the Global 7000/8000;
--BT generates slow growth, excluding the impact of foreign currency, and slightly improved EBIT margins.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

--FCF is more negative than Fitch's estimated levels of negative $2.3 billion in 2015 and negative $1 billion in 2016;
--Cash balances decline below $2 billion before there is a clear path to reach positive FCF;
--CSeries production encounters unexpected challenges or delays that increase the program's expected use of cash;
--Weak industry demand in the aerospace business, beyond the cuts already planned, leads to materially lower deliveries;
--Operating margins deteriorate consistently at BT.

Future developments that may, individually or collectively, lead to a stable Rating Outlook include:

--FCF improves and appears likely to reach a breakeven level by sometime in 2018;
--Steady improvements in segment operating margins, excluding the expected negative impact of CSeries production;
--Order rates for business and regional aircraft support high customer advances;
--Consistently lower leverage, including debt/EBITDA below 6.0x.

LIQUIDITY

BBD's liquidity at Sept. 30, 2015 included cash of $2.3 billion, down from $3.1 billion at June 30, and approximately $1.3 billion of availability under bank facilities. In addition to a $750 million bank revolver available to BBD and BA that matures in 2018, BT has a separate EUR500 million revolver that matures in 2017. Both facilities were unused. BA and BT also have letter of credit (LC) facilities that are used to support performance risk and secure advance payments from customers.

There are no material scheduled debt repayments prior to 2018, but BBD makes significant pension contributions which it estimates will total $320 million in 2015. Net pension liabilities totaled $2.1 billion at the end of 2014, including $1.35 billion at funded plans.

In addition to the two committed bank facilities, BBD has other facilities including a performance security guarantee (PSG) facility that is renewed annually as well as bilateral agreements and bilateral facilities with banks and insurance companies. BA uses committed sale and leaseback facilities ($216 million outstanding at Sept. 30, 2015) to help finance its trade-in inventory of used business aircraft. In addition, BT uses off-balance-sheet facilities that increase BBD's effective leverage. These facilities include non-recourse factoring facilities in Europe (approximately $1.1 billion outstanding at Sept. 30, 2015) and forfaiting arrangements with third party advance providers ($336 million at Sept. 30, 2015) under which BT receives funds in exchange for rights to customer payments on long-term contracts at BT.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

--IDR at 'B';
--Senior unsecured bank revolver at 'B'/'RR4';
--Senior unsecured debt at 'B'/'RR4';
--Preferred stock at 'CCC+'/'RR6'.

The Rating Outlook is Negative.

BBD's debt at Sept. 30, 2015, as calculated by Fitch, totaled approximately $9.4 billion. The amount includes sale and leaseback obligations and is adjusted for $347 million of preferred stock which Fitch gives 50% equity interest. The debt amount excludes adjustments for interest swaps reported in long-term debt as the adjustments are expected to be reversed over time.