SEPTEMBER 26TH, 2016

Fitch Affirms MTU Aero Engines AG at 'BBB-'; Outlook Stable

Fitch Ratings-Warsaw/London-08 September 2015: Fitch Ratings has affirmed Germany-based aerospace and defence company MTU Aero Engines AG’s (MTU) Long-term Issuer Default Rating (IDR) and senior unsecured rating at ‘BBB-’. The Short-term IDR has also been affirmed at ‘F3’. The Outlook on the Long-term IDR is Stable.

The ratings are supported by MTU’s strong financial profile, diverse portfolio of programmes and stability of cash flows. The Stable Outlook reflects Fitch’s expectation that financial metrics, including key measures such as earnings margins, funds from operations (FFO) and gross lease-adjusted leverage, will not change significantly in the medium term.

KEY RATING DRIVERS
Resilient Financial Profile
MTU’s ratings reflect its solid financial profile, exemplified by an FFO margin of over 7%, gross lease-adjusted leverage of around 2x, strong financial cost cover above 8x and adequate liquidity. Key ratios declined in 2014 due to development and production ramp-up on new products, but are likely to return to historical levels in the medium term as this levels off.

Good Market Position
MTU benefits from its position as a key component manufacturer for aircraft engines, exposure to a diverse range of aircraft platforms in both the commercial and defence aerospace sectors, and long-term relationships with the world’s largest engine manufacturers.

Cash Deployment
The group’s cash deployment strategy is key to the maintenance of a ‘BBB-’ rating. Fitch believes MTU is unlikely to significantly alter its dividend policy or instigate share buybacks in the short to medium term, but rather use its operating cash flows for business expansion in view of the investment needs resulting from new engine programmes in the development stage.

Limited Business Profile
The ratings are constrained by limited business diversification, restrained pricing power due to the company’s position in the production chain, and exposure to the cyclical commercial aerospace sector.

KEY ASSUMPTIONS
Fitch’s key assumptions within the rating case for MTU include:
- Revenues of around EUR4.5bn in 2015, with a continued pick-up in commercial deliveries driving due to mid-single-digit like-for-like growth, accelerated by FX effects.
- Slightly lower earnings margins in the short to medium term due to the change in the commercial product mix and decline in defence activity.
- No significant acquisitions or disposals.
- Capital expenditure of around 5% of sales in 2015 due to the entry fee related to the GE9X programme, upgrades to the company’s Munich facility, and increase in capitalisation of R&D.
- Flat dividend payments.

RATING SENSITIVITIES
Future developments that could lead to positive rating action include:
- FFO-adjusted gross leverage below 1x (2014: 2.1x, 2015E: 1.5x).
- Free cash flow (FCF) margin above 4% on a sustained basis (2014: -2.4%, 2015E: 1.3%).
- An FFO margin above 9% on a sustained basis (2014: 7.1%, 2015E: 9.1%).
- An improvement in the company’s business profile, in particular via diversification into new sectors.

Future developments that could lead to negative rating action include:
- FFO-adjusted gross leverage above 2×.
- FFO margin below 7% on a sustained basis.
- Negative FCF on a sustained basis.

LIQUIDITY
At 30 June 2015 the company had about EUR52m of readily available cash/cash equivalents (adjusting for EUR20m of intra-year cash needs) and EUR358m of available long-term committed bank lines. This compares with short-term debt of EUR62m (excluding the financial liability for the IAE-V2500 stake increase, which Fitch does not treat as debt). Fitch believes FCF is likely to be a small positive in 2015, but will consistently exceed 2% of revenue beyond 2015.