Jan 07 - Fitch Ratings says that the announcement of General Electric Corp’s (GE) EUR3.3bn purchase of AVIO SpA is likely to prove a spur towards consolidation of the Aerospace and Defence (A&D) European supply chain and increased merger and acquisition (M&A) activity in the sector over the coming 12 months involving the largest players, although mergers between the biggest OEM’s in the region remain unlikely.
Large-scale A&D M&A activity in 2012 in Europe was low by historical standards, primarily as a result of the uncertainty in the markets. Nevertheless, whilst Fitch believes that GE’s acquisition of AVIO may kick-start the process involving key suppliers, the agency does not expect the political obstacles towards mergers among the largest companies to recede.
With the notable exception of GKN Holding plc’s (‘BBB-'/Stable) acquisition of Volvo Aerospace for GBP633m, 2012 was characterised by an absence of significant transactions in the sector. Fitch expects this to change in the coming 12 months, with the larger European A&D companies likely to be bolder in M&A as acquisition becomes a favoured cash deployment and growth strategy in the context of strong balance sheets and flat local defence markets.
The agency estimates that at year-end 2012, the seven Fitch-rated European companies in the sector had over EUR20bn in cash on their balance sheets. At the same time, short term debt totalled approximately EUR5bn, nearly half of which was related party obligations pertaining to joint ventures, debt which is rolled over continuously. The ratio of cash to short term debt, at 4.1 times at year-end 2012, is the highest since 2005.
Nevertheless, it is Fitch’s expectation that a vast majority of the M&A activity in the sector in the short term is likely to take the form of key suppliers being taken over by larger OEM’s rather than mergers between these largest contractors.
The recently attempted tie-up involving European Aeronautic Defence and Space Company N.V (EADS) and BAE Systems plc or even the relatively minor asset swap proposal between Thales SA and Safran SA, both of which failed, demonstrate the extent of the political and industrial challenges facing management in their attempts to boost scale and operational efficiencies inorganically.
Despite the expected increase in M&A, Fitch does not anticipate these to lead to a spate of negative rating actions. Positive free cash generation, conservative financial strategies and, for the most part, adequate headroom under existing ratings mean that most companies can accommodate a considerable level of acquisitions without placing pressure on their ratings. Moreover, strategic portfolio alignments are unlikely to be limited to acquisitions, but also involve non-core asset disposals, thus providing further financial flexibility for acquisitions.
The seven largest European companies rated by Fitch in the A&D sector mentioned above are:
Rolls-Royce Holdings plc (‘A’/Stable);
European Aeronautic Defence and Space Company N.V. (‘BBB+'/Positive);
BAE Systems plc (‘BBB+'/Stable);
Thales SA (‘BBB+'/Negative);
Finmeccanica SpA (‘BBB-'/Negative);
MTU Aero Engines AG (‘BBB-'/Stable);
JSC Russian Helicopters (‘BB+'/Stable)