DBRS Confirms Babcock International at BBB (low), Positive Trend

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Debt rating of Babcock International Group PLC (Babcock or the Company) at BBB (low). The trend for the ratings remains Positive. Babcock’s operating performance in F2016 (year ended March 31) was largely in line with DBRS’s expectation with moderate revenue growth and steady profit margins despite weaker oil and gas-related mission critical service (MCS) business revenue and challenging equipment markets in South Africa. The Company’s adjusted debt level has not reduced as much as DBRS had expected, however, because of increased operating lease capitalization and adverse translation effect of euro-denominated debt as the Great Britain pound (GBP) weakened. As a result, Babcock’s adjusted debt-to-EBITDA only improved modestly in F2016 to 2.9 times (x) from 3.0x in F2015, which fell short of DBRS’s target level of 2.6x or lower for a rating upgrade as indicated in the last rating report published on September 22, 2015. Adjusted cash flow-to-debt also improved moderately to 28% from 26% during the same period.

Babcock’s market position remains strong in its core businesses of providing engineering and operation support programs to complex infrastructure, programs, equipment and bespoke training to personnel in critical missions. The Company also benefits from its established business relationships in the United Kingdom (U.K.) defence sector with a substantial order book of GBP 20.0 billion (or approximately 5.0x revenue excluding joint ventures (JV)) as of March 31, 2016. The confirmation of the U.K. Government’s commitment in November 2015 to spend 2.0% of annual gross domestic product on defence and increase spending in security and counter-terrorism should facilitate Babcock’s prospects in future order replenishments. This, together with the Company’s increasing penetration in international defence and MCS markets, should help to cushion the uncertain potential economic impact in the United Kingdom following Brexit.

RATING DRIVERS
In confirming the ratings and trend, DBRS recognizes the modest improvements in F2016 and maintains its expectation that Babcock could reach the target leverage level within the next six to 12 months with a substantial proportion of revenue in F2017 supported by strong order book position and its ability to maintain steady profit margins. DBRS estimates that the Company could generate annual free cash flow of GBP 150 million to GBP 200 million, which could be used to repay debt and improve financial metrics; however, the additional adverse translation impact of euro-denominated debt following Brexit as well as high capital expenditure and operating leases required to support the MCS business could potentially limit Babcock’s debt-reduction efforts and delay improvements in financial metrics. DBRS could consider upgrading the ratings by one notch when Babcock’s adjusted debt-to-EBITDA falls within the 2.6x target and can be expected to maintain its financial metrics at similar levels.

Notes:
All figures are in Great Britain pounds unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Engineering and Construction Industry (April 2016) and DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies (April 2016), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com

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