Moody's Lowers Outlook on GenCorp (GY) to Negative; Operational Gains Have Been 'Sluggish'

Moody's Investors Service has changed the rating outlook of GenCorp Inc. (NYSE: GY) to negative from stable and concurrently affirmed all of the company's ratings, including the Corporate Family Rating of B1. The rating outlook change follows increased downgrade risk as soft earnings, cash flow deficit, and debt growth over H1-FY2014 drive credit metrics that are presently weak for the rating.

Ratings:

Corporate Family, affirmed at B1

Probability of Default, affirmed at B1-PD

$460 million guaranteed second lien notes due 2021, affirmed at Ba3, LGD3

$0.2 million convertible subordinated notes due 2024, affirmed at B3, LGD6

Speculative Grade Liquidity, affirmed at SGL-3

Rating Outlook: to Negative from Stable

RATINGS RATIONALE

The negative rating outlook recognizes the sluggish pace of operational gains since the June 2013 Rocketdyne acquisition, internal revenue declines and weak credit metrics for the rating. Over H1-FY2014 debt, net of cash, rose more than $160 million with operational cash flow deficits, stock repurchases and loss on notes repurchased. In H1-FY2014 revenues, excluding Rocketdyne, declined about 20% year-over-year and EBITDA margin, excluding unusual charges, was about 11% versus 13%. Even if performance soon improves, debt may continue rising as GenCorp's effort to limit potential equity share dilution from its in-the-money convertible notes (4 1/16% due 2039, unrated) has taken debt higher, and $143 million of those notes remain outstanding. Positive free cash flow should be achievable in H2-FY2014 but the amount may not be significant without a material degree of revenue and operating margin growth. At Q2-FY2014, debt to EBITDA was 6.5x (Moody's adjusted basis, which adds back the loss on notes repurchased and business acquisition costs), high for the B1 CFR.

The B1 Corporate Family Rating has nonetheless been affirmed, reflecting GenCorp's rather strong market position and potential that financial leverage may decline near-term. GenCorp is a leading rocket propulsion company in the US and propulsion technologies represent a critical part of national defense and space systems. The company's content resides on many programs where the funding view seems solid (e.g., Space Launch System, Standard Missile, Evolved Expendable Launch Vehicle). Significantly, in H1-FY2014 GenCorp's backlog rose to $3.1 billion from $2.5 billion and some of the higher operating cost drivers in H1 will likely not repeat in H2.

The Speculative Grade Liquidity Rating has been affirmed at SGL-3, denoting an adequate liquidity profile. A good revolver borrowing availability level is a key support to the liquidity rating, particularly as the company's pending RD Amross merger agreement carries a $110 million minimum liquidity requirement. While the $143 million of convertible notes can be put in December 2014, likelihood of put is low with the notes well in-the-money and a put can be settled in cash or stock at the company's option, as defined in the indenture. Financial ratio covenant test headroom under the first lien bank credit facility should remain sufficient, but if earnings do not soon rise, cushion could quickly erode.

The rating could be downgraded if debt to EBITDA continues above the mid-5x level by early FY2015, liquidity weakens, or if free cash flow does not develop over H2-FY2014. Stabilization of the rating outlook would depend on expectation of debt to EBITDA below 5x, free cash flow to debt of 5% or higher and sustained adequate liquidity.

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