Fitch Affirms General Dynamics at 'A'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed General Dynamics Corporation's (GD) Long-Term Issuer Default Rating (IDR) and long-term debt rating at 'A'. Fitch has also affirmed GD's short-term IDR at 'F1'. The Rating Outlook is Stable. Approximately $4 billion of outstanding debt is covered by these ratings. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The affirmation of the company's ratings and Stable Outlook are supported by solid credit metrics, strong free cash flow (FCF; cash from operations less capital expenditures and dividends), financial flexibility and strong liquidity position, competitive positions in business jets and defense, and large backlog. Another positive factor is the level of diversity in GD's portfolio of products and services, both domestically and internationally, including military and commercial ship building, ground combat systems and business jets.

GD has strong credit metrics for the ratings. Fitch projects that gross leverage (debt/EBITDA) and adjusted leverage (adjusted debt/EBITDAR) will be 0.8x and 1.2x, respectively, at the end of 2016, up slightly from 0.7x and 1.1x at the end of the prior year due to the issuance of $1 billion of senior unsecured notes in August 2016. The new $1 billion notes effectively replaced $500 million of senior notes repaid in July 2016 and $500 million of senior notes that were repaid in January of 2015. Fitch notes, however, despite the slight increase in 2016, leverage ratios still reflect improvement from levels reported between 2011 and 2014 when debt/EBITDA averaged 0.9x.

GD's conservative financial profile and effective operating strategy helped the company maintain a strong credit profile through the economic downturn. GD typically generates above $2.5 billion pre-dividend FCF annually, has manageable capex of 1.5%-1.8% of sales and its minimum required pension contributions are insignificant as a percentage of operating cash flows. The company could issue more than $2.5 billion of debt before it breaches Fitch's negative leverage sensitively threshold.

GD typically converts 100% of its net income into cash but Fitch expects cash conversion will be at approximately 70% in 2016. Cash conversion fell to approximately 65% in 2015 due to higher capex, a build-up of inventory and working off the large advanced payments received in 2014 on several major programs. However, Fitch anticipates it will increase to historical levels beginning in 2017 driven by the completion of Jones Act ships and an increase in cash flows associated with the full-rate production of several international orders in the Combat segment. Future cash flows should also be aided by the expected deliveries of the new G500 and G600 aircraft in 2018 and 2019. The company generated $1.9 billion of pre-dividend FCF in 2015. Fitch expects GD will generate approximately $2 billion in 2016 and $3 billion-$3.2 billion in 2017.

GD continued to direct cash deployment to shareholders in 2015, despite lower FCF, as it paid $873 million in dividends and repurchased approximately $3 billion shares. In the first quarter of 2016, the board of directors authorized a repurchase program for up to 10 million additional shares. As of July 3, 2016, GD had repurchased $1.2 billion shares and paid $447 million dividends. Fitch expects the company will steadily increase dividend payments, which are estimated at $900 million-$1 billion annually over the next two years, and will repurchase approximately $2 billion shares each year. The aggressive cash deployment is mitigated by the company's ability to build sizable cash balances by reducing its share repurchases.

Even though Fitch is concerned by the aggressive cash deployment towards shareholders, this concern is mitigated by conservative financial policies. During the previous downturn, the company built sizable cash balances by significantly reducing its share repurchases in 2012 and 2013 in response to a slowdown in the business jet market and the U.S. budgetary pressures.

Fitch is also concerned by GD's exposure to possible declines in U.S. and international defense spending, as well as the uncertainty of the timing of international orders. The company does not disclose its international military sales; however, it derives approximately 57% of its revenues from the U.S. government including 47% from the U.S. Department of Defense. As a result, defense spending is a significant driver of GD's financial performance and credit quality.

U.S. defense spending has increased in fiscal year (FY) 2016 as investment spending turned up this year after a three-year trough. Three agreements between the White House and Congress have provided relief from the Budget Control Act (BCA) of 2011, but projected spending beyond FY2017 is above the budget caps, so caps remain a risk through 2021. Fitch bases its defense ratings on the assumption that the caps will continue to be overridden, but at lower levels than those projected by the government after FY2017.

A dramatic and unexpected change in U.S. defense spending policies could negatively impact GD's credit profile. In addition, the company may be adversely affected by changes in the U.S. Navy shipbuilding plans, as the Marine Systems segment derives a significant portion of its revenues from building Virginia-class submarines and the Arleigh Burke-class guided missile destroyers. Fitch believes modest declines in defense spending would not necessarily lead to negative rating actions given GD's current credit metrics, liquidity position and diversified product portfolio and the strategic importance of the naval products. The exposure to the U.S. military spending is also mitigated by the company's commercial sales at a combined 43% of total revenues in 2015.

Fitch notes there is execution risk surrounding entry into service of two new large-cabin business jets announced in 2014 (the G500, and the G600). Demand for the two new large-cabin business jets has been robust but has negatively affected demand for the G450 and G550 models. Fitch anticipates lower revenues in the Aerospace segment over the next several years but the long term impact is mitigated by a significant backlog for the G650 and the G650ER aircraft, as well as recent meaningful margin improvements due to cost savings initiatives. The company has indicated it has flexibility to pull forward production for the G650 and the G650ER aircraft and fill in a possible production gap should the demand for the G450 and the G550 fall dramatically.

GD's sizable pension deficit is mitigated by strong cash generation. The company's defined benefit pension obligations totaled $12.5 billion and were 68% funded ($3.9 billion underfunded) at the end of 2015. Even though GD's total pension obligation decreased by approximately $680 million in 2015, the underfunded status remained unchanged at 68% from the prior year. Despite the unchanged underfunded status of the pension liabilities, the company's minimum required contributions declined significantly in 2015 due to the beneficial impact from the passage of the Highway and Transportation Funding Act of 2014 (HATFA). GD contributed $187 million towards its pension plans in 2015, down from $550 million in 2014. The company plans to contribute approximately $200 million to the pension plans in 2016. Fitch believes cash contributions will not have a significant effect on the company's cash deployment strategy in the near future.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for GD include:

--Flat sales in 2016 and low single digit annual revenue growth beginning in 2017;

--Steady EBITDA margins in the range of 14.5% to 15.5%;

--Combined net share repurchases and dividend payments will be above $2.5 billion annually and will roughly equal to the company's net income.

--Similar to 2015 results, post dividend FCF margins will be in the range of 3.5% to 4% in 2016. FCF margins will rebound beginning in 2017 and will be in the range of 6% to 7%.

--Capital expenditures will remain steady in the range of 1.7% to 1.8% of revenues;

--Debt maturities will be refinanced and leverage will remain constant;

--Share repurchases will be reduced if the company makes material acquisitions;

--Pension contributions will not be a significant portion of the company's cash deployment in the near future.

RATING SENSITIVITIES

Fitch would consider a negative rating action if the company's leverage (debt/EBITDA) deteriorates to 1.3x-1.5x or funds from operations (FFO)-adjusted leverage to 2.1x-2.3x, due to a cancellation of key programs, a significant downturn in the business jet sector or unsuccessful attempts to reduce costs in line with potential revenue reductions. The company has significant financial flexibility and its credit metrics could sustain moderate deterioration without pressuring the current ratings.

A positive rating action is unlikely in the near term due to the Aerospace segment's cyclical nature and some uncertainty in the U.S. defense spending outlook and its impact on the Information Systems & Technology (IS&T) segment. Fitch may consider a positive rating action if the company modifies its cash deployment strategy, which currently targets a return of 100% of net income to shareholders in the form of share repurchases and dividends.

LIQUIDITY

As of June 30, 2016, GD maintained approximately $3.9 billion total liquidity consisting of $1.9 billion in cash and full availability under its $2.0 billion revolving credit facility. The company maintained significantly higher liquidity during the past five years to mitigate increased uncertainties in the U.S. DoD spending and a severe downturn in the business jet markets. GD's liquidity reached as high as $7.3 billion at the end of 2013 and has been decreasing since, a result of share repurchases and dividends. Fitch expects the company's liquidity to remain at approximately $4 billion over the rating horizon.

GD's debt structure consists of senior unsecured notes denominated in U.S. dollars. Most of the debt is issued by the parent company and guaranteed by subsidiaries accounting for approximately 87% of revenues in 2015. The nonguarantor entities are principally foreign subsidiaries. The next large maturity is in November 2017 when a total of $900 million senior unsecured notes are due. Fitch believes the company will be able to repay these notes with cash on hand, but refinancing is more likely as Fitch expects the company will maintain its current leverage.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

General Dynamics Corporation

--IDR at 'A';

--Senior unsecured debt at 'A';

--Credit facilities at 'A';

--Short-Term IDR at 'F1';

--Commercial paper at 'F1'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1012590

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012590

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
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or
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Source: Fitch Ratings

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