Moody's Cuts Michael Baker Corp. (BKR) to 'B3'; Notes Weak Liquidity, Low FCF Generation, Interest Coverage

Moody's Investors Service has downgraded ratings of Michael Baker Holdings, LLC, (NYSE: BKR) including the Corporate Family Rating to B3 from B2. The rating outlook is Stable. The rating downgrade results from weak liquidity, low free cash flow generation and interest coverage.

RATINGS RATIONALE

The B3 CFR reflects low interest coverage and cash flow generation, but also good scale and diversity of service offerings that favors bidding prospects. At Q2-2015 LTM EBITDA less capital expenditures to interest was 1.4x on a Moody's adjusted basis (which includes holding company debt) with no free cash flow generation. While revenue and earnings improved in Q2-2015 sequentially and year-over-year, performance has been choppy since the leveraged dividend of April 2014. Free cash flow generation will probably remain soft until mid-2016 as contracts underway will likely drive capital spending and working capital growth. Michael Baker's scale and business integration initiatives may ultimately produce greater efficiencies, steadier profit/cash flows, but progress is taking longer than expected. Broad qualifications for construction and engineering work in developing regions and within the U.S. (federal, state and local) help the company compete for large contracts and favor the long-term revenue view.

A liquidity profile that is deemed to be weak also factors into the CFR. The low free cash flow generation that is envisioned near-term will likely keep the company heavily dependent on its revolving credit line. About $75 million of borrowings existed under the asset-based revolver at June 30, 2015, leaving availability of less than $50 million, a minimal amount against the company's size and in light of its working capital swings. Further, a demanding covenant test could activate later in the year without steady earnings across July-December. Scheduled debt maturities are minimal until 2018 which partially lessens pressure on the CFR from weak liquidity.

The stable rating outlook anticipates improved working capital efficiency and better free cash flow after mid-2016 as receivable growth under a large contract should by then stabilize, providing cash flow to reduce revolver borrowing and improve liquidity.

Downgrades:

..Issuer: Michael Baker Holdings LLC

.... Probability of Default Rating, Downgraded to B3-PD from B2-PD

.... Corporate Family Rating, Downgraded to B3 from B2

....Senior Unsecured Regular Bond/Debenture, Downgraded to Caa2 (LGD6) from Caa1 (LGD6)

..Issuer: Michael Baker International, LLC

....Senior Secured Regular Bond/Debenture, Downgraded to B2 (LGD3) from B1 (LGD3)

Outlook Actions:

..Issuer: Michael Baker Holdings LLC

....Outlook, Changed To Stable From Negative

..Issuer: Michael Baker International, LLC

....Outlook, Changed To Stable From Negative

Downward rating pressure would mount with likelihood of a covenant breach, expectation of low free cash flow across 2016, or debt/EBITDA approaching 7x (was 6x at Q2-2015). Before the liquidity cushion expands, the extent to which the operating company up-streams cash to the holding company will also be considered. Upward rating momentum would depend on expectation of free cash flow to debt in the high single digit percentage range, debt/EBITDA closer to 5x, and steady backlog.

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