BAE Systems outlook upgraded to positive by Moody’s Ratings

Investing.com -- Moody’s (NYSE:MCO) Ratings has upgraded the outlook for UK-based defense contractor BAE Systems (LON:BAES) from stable to positive, while maintaining its Baa1 long-term issuer and senior unsecured ratings. The revised outlook also applies to the backed senior unsecured instruments issued by BAE Systems Holdings Inc. and BAE Systems Finance Inc., and the P-2 short term rating on the backed commercial paper issued by BAE Systems Holdings Inc.

The change in outlook comes in light of the company’s solid medium to long term growth prospects, despite ongoing supply chain challenges and political uncertainty. BAE Systems’ strong execution track record and a financial policy that balances shareholder distributions, some debt-financed acquisitions, and EBITDA- and cash flow-driven deleveraging were also noted.

Moody’s Baa1 ratings reflect BAE Systems’ large scale and long-term defense contracts, diversified product base, and strategic supplier position to the UK, US, Saudi Arabian, and Australian governments. The ratings also take into account the company’s technological leadership and high barriers to entry, alongside a balanced financial policy with expected leverage reduction to about 2.5x.

However, the ratings also consider the company’s geographical concentration in the UK, the US, and Saudi Arabia, which exposes BAE to political risk or shifting priorities. Global supply chain constraints, persistent inflation, risks over export license regimes in relation to Saudi Arabia, and the potential for a degree of releveraging from acquisitions and shareholder distributions are also factored in.

BAE Systems is forecasted to achieve organic revenue growth around mid-single digit percentage rates, with the potential for slight margin expansion. Profit growth is expected to drive organic deleveraging from around 2.8x anticipated for 2024, following the issuance of GBP3.8 billion equivalent debt to fund the acquisition of Ball (NYSE:BALL) Aerospace and refinance bond maturities.

The company’s liquidity is excellent, benefiting from cash and cash equivalents of around GBP2.8 billion as of June 30, 2024, and an undrawn revolving credit facility of GBP2 billion maturing in September 2029. A bond maturity of $750 million (around GBP613 million) is due in December 2025.

The positive outlook reflects the robust nature of BAE Systems’ programme portfolio and solid contract execution, which is expected to lead to EBITDA-driven deleveraging. The outlook could return to stable if trading performance and financial policies result in limited improvements in credit ratios from here onwards, including Moody’s-adjusted gross debt/EBITDA maintained in a 2.5x-3.0x range.

The ratings could be upgraded if the company sustainably maintains a solid outlook for its programme portfolio, a record of effective contract execution, and Moody’s-adjusted debt/EBITDA below 2.5x, among other factors. However, a ratings downgrade over time is possible if there are significant execution issues on key contracts, or if the company’s programme portfolio shows a declining profile, among other potential concerns.

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