DBRS Confirms Bombardier Inc. at BB with Stable Trend

DBRS has today confirmed the Issuer Rating and the Senior Unsecured Debentures rating of Bombardier Inc. (BBD or the Company) at BB with a Stable trend. BBD’s Preferred Shares have also been confirmed at Pfd-4 with a Stable trend. The confirmation reflects our expectation that the Company’s financial measures, while acceptable for the current rating, are unlikely to materially improve in the next two to three years because of high capex requirements, continued demand uncertainty in the Company’s aerospace division (BA, accounting for about half of total EBIDTA in the first half of 2012) and softening of economic conditions in Europe and Asia Pacific, two of BBD’s key geographic markets. BBD is a leading global manufacturer of transportation equipment, including a broad range of business and commercial aircraft as well as rail transportation equipment.

DBRS believes that the business risk profile of BBD’s transportation division (BT, contributing to the remaining half of total EBITDA) is adequate and moderately stronger than that of its BA division. BT is supported by its market-leading position, particularly in rolling stock, although this is partly offset by its single-digit EBIT margin. Despite its cost focus and steadily improving profitability and execution track record over the past six years, the low operating margin and complexity in contract execution could leave little room for problems or delay. BA’s business risk profile is weak, in view of volatile demand conditions and significant execution risks associated with the ongoing aircraft development programs. Although these product developments could enhance BA’s long-term market positions in both the business and commercial aircraft segments, they would likely result in negative free cash flow for BA in the next two to three years.

Since the beginning of calendar year 2011, DBRS observed recovery in order intake in both the business and commercial aircraft segments. In the business jet segment, orders are mainly related to medium-to-large aircraft and driven partly by increasing globalization supporting demand for longer-range aircraft and demand by fractional ownership operators, while BDD’s project to rejuvenate the lighter Learjet is ongoing. In the commercial aircraft segment, improved travel demand and load factors, replacement demand for aging fleet and increasing regional air travel have contributed to continued order intake. Total aerospace backlog as at June 30, 2012, was $25.2 billion (approximately 2.5 to 3.0 times (x) annual revenue for the division) from $22.0 billion at December 31, 2011. As BBD delivers on the higher backlog on the aircraft types currently in production, the Company expects the division’s operating cash flow to substantially finance the $2.0 billion capex expected in 2012.

As the C-series aircraft development program progresses toward entry-into-service (scheduled around the end of 2013), BBD has made progress in acquiring new orders with C-series firm order backlog of 138 aircraft and options for an additional 124. As at June 30, 2012, C-series contributed to about 62% of total commercial aircraft backlog by units and likely a higher proportion of backlog value; as such, DBRS believes that the successful execution of the development and production of C-series has assumed increasing importance to BBD’s future cash flow and financial metrics. While BBD has maintained that the C-series program is currently on schedule and budget, we believe that the program is now at a critical stage of development with the aircraft’s fly-by-wire system currently being tested and first flight being planned before end of 2012. The successful implementation in these two stages will be crucial to the timely certification and commercial production of the new aircraft. Conversely, if problems surface during these two stages, they could potentially cause delays and increased costs, the magnitude of which is not possible to determine at this stage.

While the BT division maintains strong market position and product capability, it is experiencing some near-term challenges, which include execution issues in some of its projects, difficult economic conditions in Europe and signs of slowing rail infrastructure spending in Asia Pacific. The EBIT margin improvement that BT achieved for six consecutive years has stalled at 7.2% in the 11-months ended December 31, 2011 (fiscal December 2011), because of execution issues in some of the projects. With lower revenue in the first half of 2012 due to a timing issue (as large projects were completed while newer projects were still being ramped up), in order to cover fixed overheads and selling expenses, the EBIT margin further declined to 6.2%. We understand that BBD has continued BT’s focus on project execution and cost management efforts, and maintained its EBIT margin target unchanged at 8% by 2013. As DBRS expects BT to remain an important contributor to BBD’s future capex needs (especially those in BA) in the next two to three years, its profitability and cash flow will have an impact on the Company’s borrowing needs and financial metrics. BDD’s financial metrics have weakened steadily since fiscal year ended January 31, 2010, as the Company increased its borrowing to finance part of its large investments in its aircraft development programs. Adjusted debt-to-EBITDA was 3.4x and cash flow-to-total debt was 24% for the fiscal period ended December 31, 2011 (on an annualized basis), compared to 2.8x and 28%, respectively, for fiscal year ended January 31, 2010.

Going forward, DBRS projects a base case scenario in which we expect (1) revenue to grow by 8% to 10% from 2013 to 2015 to reflect the start of deliveries under the new aircraft programs and execution of the current sizeable backlog, (2) EBIT margin to range from 6.5% to 6.8% (reflecting modest margin improvement in BA and attainment of 8% target in BT), (3) capex of $2.0 billion in 2012 and 20% of revenue thereafter and (4) no additional equity issuance. The assumptions also reflect our expectation of on-time completion and deliveries of the C-series and Learjet 85 programs. With these assumptions, we project that BBD’s financial measures could weaken further from fiscal December 2011 levels, with adjusted debt-to-EBITDA between 3.5x and 4.0x and cash flow-to-adjusted debt around 20% to 22% over the next few years. DBRS expects more meaningful improvement to occur only after 2015. We are mindful that with the aircraft development programs at a critical testing stage and slower economic conditions in key BT markets, financial metrics could be weaker than expected in the event of delays in C-series and Learjet 85 deliveries or lower revenue from key BT markets.

With continued capex spending in the next two to three years effectively limiting BBD’s ability to reduce its leverage and improve its financial metrics, we do not expect the Company’s rating to be raised until the C-series and Learjet developments are completed with regular productions and deliveries, and financial metrics begin to improve. Conversely, any material problems or delays in these programs that could affect BBD’s market standing as an aircraft manufacturer or materially increase development costs could result in negative rating action.

Notes:
All figures are in U.S. dollars unless otherwise noted.

This is an unsolicited rating. This rating was not initiated at the request of the issuer or rated entity and did not include participation by the issuer or any related third party.

The applicable methodologies are Rating Companies in the Industrial Products Industry (June 2011) and DBRS Criteria: Rating Leveraged Finance (June 2011), which can be found on our website under Methodologies.