Dec 13 - Fitch Ratings has assigned Deutsche Post AG’s (DP) EUR1bn seven-year convertible bond, EUR300m eight-year and EUR700m 12-year notes a ‘BBB+’ rating. The ratings are in line with DP’s senior unsecured ‘BBB+’ rating. The convertible bond has a covenant structure that mirrors the senior unsecured debt obligations. DP’s long-term Issuer Default Rating (IDR) is ‘BBB+’ with a Stable Outlook, short-term IDR is ‘F2’.
Proceeds from the multi-tranche bonds issue will be used to further fund DP’s German pension obligations. Given its approach to unfunded pension schemes, such as that of DP, Fitch views this transaction (an increase of lease adjusted net debt by EUR2bn) as marginally credit negative as the Fitch-expected funds from operations lease adjusted net leverage is set to increase by around 0.4x on average for 2012-14 from around 3.0x expected pre-transaction. However, the rating impact is neutral because leverage is expected to remain within the guideline for the ‘BBB+’ rating at 3.5x.
The agency notes that the projected debt service of the new debt (c. EUR32m p.a.) will be offset by lower ongoing contributions to the scheme. As such, Fitch estimates that FFO fixed charge coverage will remain unchanged.
For unfunded pension schemes like many in Germany, Fitch’s pension-adjusted leverage methodology recognises only a portion of the funded status, equal to a ratio of balance sheet debt to total assets (adjusted for funding status), assuming that the pension cash flow drain is less immediate. The transaction will improve the funding status of DP, but increase pension-adjusted debt. However the pension-adjusted leverage ratio will increase by less than the lease adjusted leverage used as the rating guideline. See ‘Treatment of Corporate Pensions - EMEA and Asia-Pacific Special Report’ dated August 2011 at www.fitchratings.com.
DP’s rating reflect its well-integrated business profile, dominant market position in the domestic mail and parcel market and a strong global footprint in the express, global freight forwarding and supply chain businesses, through its DHL brand. After the completion of the sale of Postbank shares in H112, DP benefits from greater financial flexibility and balance sheet transparency, with an expectation of continued positive underlying free cash flow in the near term.
Stronger Financial Profile
Finances have been on an improving trend. Fitch expects lease-adjusted FFO net leverage at YE12 to decrease from 4.4x at YE11. According to Fitch’s forecasts, DP’s free cash flow, in an absence of extraordinary dividends or share buy backs, should remain positive over the next two to three years. DP benefits from a competitive cost of debt and comfortable interest cover ratio. However, the Fitch expected fixed charge coverage (including operating leasing) for DP is tight at below 3.0x.
Commensurate Business Risk
The rating is constrained to the ‘BBB’ category as a result of DP’s high exposure to global market volatility through its DHL businesses: express, freight forwarding and supply chain, representing 67% of the group’s EBITDA. DP’s traditional mail business is more exposed to the domestic economic cycle, and is in structural decline, facing increasing competition and a high fixed cost base. Management’s targets to maintain the divisional contribution to the group unchanged will require significant investments and Fitch views the targets as challenging. The postal rate price increase recently agreed by the Federal Network Agency and expected parcel growth will help improve the division’s margins from 2013. The agency believes that the secular changes affecting the mail industry, including competition from electronic communication and digitalization leading to structural volume decline, have significantly increased DP’s mail business risk.
Varying Capital Intensity
DP’s capital intensity ranges from high for the mail and express businesses to the asset-light nature of the freight forwarding and supply chain businesses. However, profit margins are narrow for the latter and higher for mail and express. Profit margins for express are recovering compared with its major competitors after a difficult and costly phase of restructuring due to the exit from the domestic US market in 2009. Mail’s declining profit margin is constrained by staff costs (wages and pensions), declining mail volumes and exposure to increasing fuel costs only partially hedged or passed through to end-customers.
Well Placed Compared to Peers
Within its peer group, Fitch believes that DP compares well and in places is stronger when considering the degree of business integration, global footprint and brand recognition. Similar to UPS and FedEx, DP’s profile is supported by a strong and highly export-driven domestic economy. Differences arise when comparing legacy issues from M&A growth, relevant for DP, but less so for the US companies. Furthermore, Fitch considers that European operators are currently more exposed to regulatory and litigation risks, as evidenced by the EU antitrust and state aid investigations that DP is currently facing.
The Stable Outlook reflects the improvements in the financial profile after the disposal of Postbank and the recovery of the express business’s profits and market share (with the latter also the case for the global freight forwarding segment) that offset the currently challenging macroeconomic environment.
Negative: Future developments that could lead to negative rating action include:
FFO lease adjusted net leverage above 3.5x on a sustained basis and FFO fixed charges coverage below 2.0x; credit profile shifting towards more asset-heavy businesses; significant deterioration in business fundamentals due to a protracted economic downturn leading to significant volume and margins reduction in the DHL divisions.
Positive: Future developments that could lead to positive rating action include:
FFO lease adjusted net leverage below 2.5x on a sustained basis and FFO fixed charges coverage above 3.5x on a sustained basis; improving macro-economic outlook; successful e-substitution strategy, continued success in expanding of domestic parcel business, partially compensating the declining traditional mail profits.
Liquidity, including an unused EUR2bn revolving facility is adequate considering the debt maturity profile and the expectation of positive free cash flows.