Fitch Ratings-New York-28 April 2017: Fitch Ratings has affirmed the Boeing Company’s (BA) Long-term Issuer Default Rating (IDR) at ‘A’ and Short-term IDR at ‘F1’. Fitch has also affirmed Boeing Capital Corporation’s (BCC) Long-term IDR at ‘A’. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

The ratings cover approximately $10.8 billion of debt ($7.7 billion attributable to BA and $3.1 billion attributable to Boeing Capital), up from approximately $10 billion at the end of 2016. Boeing issued $900 million of senior notes in February, which drove the higher debt level. Of the amount attributable to Boeing Capital, less than $1 billion consists of debt originally issued by BCC and subsequently guaranteed by BA, with the remainder consisting of intercompany loans from BA to Boeing Capital. Fitch’s ratings incorporate expectations for higher debt in 2017 and subsequent years, and Fitch believes BA could end 2017 in a net debt position for the first time in six years.

KEY RATING DRIVERS

BA’s ratings reflect its competitive positions in the commercial aerospace and defense sectors, high barriers to entry in its key businesses, liquidity position, strong cash generation, valuable technology in both sectors, and large backlog ($480 billion). The ratings are also supported by the company’s demonstrated ability to withstand challenging periods such as the post-9/11 downturn, the most recent economic recession, and the 787/747-8 development delays.

BA has earned credit for lowering its risk profile by shifting a substantial number of employees to defined contribution benefit plans, signing long-term labor agreements, and successfully executing a significant number of aircraft production rate changes over the past several years. The company’s risk profile benefits from strong financial flexibility, particularly the company’s track record of shutting off share repurchases in times of stress.

Concerns include low margin levels for the rating category; the aging of some of Boeing’s defense programs; some remaining uncertainty about the ultimate profitability of the 787 program; the potential for delays and cost overruns on development programs; and regular and substantial charges related to both development and production programs. Other concerns include the size of the company’s pension deficit on a GAAP basis ($20 billion); pricing trends for some aircraft models; and the susceptibility of the commercial aerospace industry to shocks such as terrorism and disease. Also, the company’s portfolio is less balanced than it once was, as commercial growth has reduced defense revenues to less than one-third of consolidated revenues. The intense competitiveness of the commercial airplane industry is also a rating consideration.

Aggressive cash deployment to shareholders is not currently a threat to the rating, as it has generally been funded from operating cash flow. However, it has slowed the improvement in BA’s credit profile. BA’s focus on share repurchases and dividend increases is coming at the expense of debt reductions and pension contributions. BA repurchased $7 billion of shares in 2016, and in December its board approved a new $14 billion repurchase program, as well as a 30% dividend increase. Share repurchases in the first quarter of 2017 totalled $2.5 billion. Fitch estimates dividend payments will exceed $3.3 billion in 2017, up from almost $2.8 billion in 2016.

Boeing Global Services

In the second half of 2017 BA will establish a third business segment called Boeing Global Services (BGS), targeting a substantial long-term increase in both commercial and defense services revenues, with a long-term annual revenue target of $50 billion. Fitch considers this a significant strategic initiative, and it could materially affect financial results, cash deployment, and program decisions over the intermediate term.

The new unit will aim to capture more services and support revenue through the life cycle of Boeing’s aircraft and equipment, and it will attempt to leverage BA’s existing large installed base and strong market positions. Boeing’s revenue target for the segment is a substantial increase from Fitch’s estimate of BA’s current services revenue in the high teen billions. Some growth should come from the expected market increases in both commercial and defense, but Fitch expects BA will have to either take market share from other players or buy business to reach its target. Fitch believes the greater emphasis on life-cycle services could affect some elements of BA’s business model, including decisions to launch new programs. The New Midsize Airplane (NMA) is a program to watch.

There are several potential risks to the BGS initiative. First, the impact on cash resources is unclear at this point, with little guidance on investment, working capital needs, or M&A spending. Secondly, BA will likely need to take market share from existing players, which could affect parts of the supply chain. Finally, the success of the strategy is uncertain; this is not the first time that Boeing has emphasized services, and there are not enough details yet to determine if this new structure will lead to substantial increases in revenues and profits.

Commercial Airplanes Segment and Outlook

Fitch expects Boeing’s commercial aircraft deliveries will rebound to approximately 770 aircraft in 2017 and 820 aircraft in 2018. Several transitioning programs drove BA’s 2016 deliveries down modestly to 748 aircraft. BA’s commercial backlog at the end of March 2017 totalled 5,744 aircraft, reflecting the health of Boeing’s commercial franchise. However, the backlog declined by 80 aircraft in 2016. This was the first backlog decline at BA in six years. Given some trends in the LCA market, Fitch expects orders could come in below deliveries again in 2017, lowering the backlog further. This is not a rating concern at this time given the large existing order book.

Most key commercial aviation indicators support Fitch’s aircraft delivery outlook. However, there are several signs that the positive momentum in some demand indicators is slowing and a delivery peak is looming. Fitch expects aircraft orders and the order backlog to decline in 2017. Airline profits are likely to fall modestly in 2017, and passenger airline traffic growth could decelerate. Announced production rates show substantial delivery growth, and Fitch forecasts that deliveries could be approaching a level exceeding replacement needs and growth.

787 Program

The 787 program remains a key driver of BA’s growth and competitive position. Many risks have been retired, and after a difficult development process, the 787 is now well established in the aviation market. The 500th 787 was delivered in 2016. The 787 is one of the most attractive types of collateral in the aircraft finance business. Fitch estimates the program could currently account for
$15 billion or more of annual revenues.

However, Fitch still has some concerns about the 787’s ultimate profitability and cash generation. After delivering roughly 38% of the program accounting quantity (500 aircraft out of 1,300) the program is still operating at only near break-even gross margins, according to BA’s SEC filings. The program has accumulated $27.3 billion of deferred production costs through 2016, although this amount has declined modestly from the end of 2015. Overall, the 787 accounted for $38.5 billion of inventory at year-end 2016, down from $41.2 billion at year-end 2015.

Defense, Space, and Security

U.S. defense investment spending increased in 2016 after a three-year trough and Fitch expects continued solid spending levels in 2017 and beyond. Risks remain from budget caps and political inertia. Fitch considers BA’s defense portfolio to be of mixed quality, with some solid programs offset by a group of aging programs. BA’s defense business is still a large contributor to the company’s results despite its various challenges. Revenues should be around $28 to 29 billion annually, with approximately 10% to 11% operating margins. Orders were strong in the first quarter of 2017, and the segment ended the quarter with a backlog of $63 billion. International sales are a strong point, representing 34% of backlog. Cost reduction remains one of the key elements of BA’s defense sector strategy.

Metrics and Margins

At Dec. 31, 2016 BA’s leverage (debt/EBITDA) was 1.0x, up from 0.9x at the end of 2015. Total debt increased almost $1.9 billion since the end of 2014, ($8.9 billion at year-end 2014 to $10.8 billion as of March 2017), and Fitch expects debt will rise further in 2017. In 2017, Fitch forecasts a modest increase in leverage, which will then decline through the rating horizon due to higher projected revenue and EBITDA margins. Fitch estimates leverage excluding debt attributable to BCC was 0.7x for 2016 and 0.6x in 2015. Fitch calculates that BA’s EBITDA margins fell 70 basis points in 2016 to 11.0%. Fitch believes this decline came from challenges on several large programs and dilution from the 787.

BCC

Fitch views BCC as a core subsidiary of BA, reflecting its role arranging, structuring, and providing financing to support the sale of BA’s products. The rating linkages are also based on the high level of management and operational integration between the two entities, as well as BA’s track record of support for BCC, reflecting the fungibility of funding between the two entities. Consistent with Fitch’s ‘Global Non-Bank Financial Institutions Rating Criteria’, the ratings of core subsidiaries are equalized with those of its parent.

In addition, BA has provided unconditional guarantees for the due and punctual payment and performance of all of BCC’s outstanding publicly issued debt. Fitch views the parent guarantees as the strongest form of parental support, which in Fitch’s view, further enhances the rating linkages between the parent and subsidiary. BCC has historically exhibited sound operating performance, stable asset quality, and sufficient liquidity profile, although its standalone credit risk profile would likely be lower than ‘A’ given the cyclicality and residual value risk associated with the aircraft leasing business, the credit risk profile of BCC’s lessors and its elevated leverage levels relative to standalone aircraft lessors.

BCC’s operating performance is consistent with the company’s operating strategy focused on minimizing the use of its balance sheet in support of BA’s aircraft sales. Segment revenues and operating income have remained relatively flat driven by portfolio run-off and aircraft sales, offset by modest new origination activity. Asset quality performance has also remained relatively stable over the years, as the company has worked through a number of credit issues within its portfolio, and reduced overall risk resulting from a decrease in customer financing. Fitch believes that current loss reserves, and direct BA support should provide sufficient support relative to potential losses on receivables.

In most cases where an industrial company has a captive finance subsidiary Fitch deconsolidates the subsidiary and then evaluates the parent’s financial statements treating the subsidiary as an equity investment. In the case of BA, Fitch does not follow this process, but instead looks at financial metrics primarily on a consolidated basis. Fitch looks at BA and BCC on a consolidated basis because BCC has evolved into a less significant part of BA’s financials as a result of the successful strategic shift to reduce BCC’s emphasis on portfolio growth and increase its focus on facilitating third-party financing for its customers. BCC’s primary strategic mission is not lending to BA’s customers, but only occasionally financing aircraft, with approximately 99% of BA’s deliveries typically financed by third parties.

KEY ASSUMPTIONS

Fitch’s key assumptions within the rating case for the issuer include:

—Large commercial aircraft deliveries up to 770 aircraft in 2017 and approximately 820 in 2018;
—In 2017 both commercial aircraft revenue and defense revenue decline, but commercial revenues rebound in 2018;
—EBITDA Margins in 2017 rise 25 bps;
—Refinancing of all debt maturities;
—Substantial share repurchases and dividend increases; and
—Share repurchases will be suspended in the event of liquidity pressures or an industry shock.

RATING SENSITIVITIES

Positive rating actions could be driven by an improvement in BA’s credit profile from higher commercial aircraft deliveries, debt reduction and pension contributions. BA’s margins are low for the rating category, so several initiatives to boost margins, if successful, could also drive positive rating actions. Modifying the cash deployment strategy to have less focus on share repurchases could also lead to positive ratings actions.

There could be a negative rating action if there are material negative developments with any of the company’s major programs leading to delivery delays, order cancellations, large additional costs or inventory write-downs. Large acquisitions, although not anticipated, also could affect the ratings, as could debt-funded share repurchases. Sustained consolidated FFO-adjusted leverage approaching 2.0x could lead to a negative action.

BCC’s ratings and Rating Outlook are linked to those of its parent. Positive rating actions would be limited to Fitch’s view of BA’s credit profile, thus Fitch cannot envisage a scenario where the captive would be rated higher than its parent. Conversely, negative rating actions could be driven by a change in BA’s ratings or from a change in the perceived relationship between BCC and BA, including the early termination of the parent guarantee prior to the repayment of BCC’s outstanding publicly issued debt.

LIQUIDITY

As of Dec. 31, 2016 BA had a strong consolidated liquidity position of approximately $15 billion. This consisted of $10 billion in cash and investments, and complete availability under $5 billion of bank facilities. The bank facilities are split into two $2.5 billion parts, one expiring in November 2017 and the bulk of the other in November 2021. At the end of the first quarter of 2017, liquidity dipped to $14.2 billion, as cash and marketable securities declined to $9.2 billion.

Debt maturities are manageable over the next two years at $387 million in 2017 and $714 million in 2018. Required pension contributions are modest given BA’s pension is over 100% funded on an ERISA basis, but the company expects to contribute approximately $500 million to its plans in 2017. Required pension contributions could rise after 2017.

Boeing’s FCF (cash from operations, less capex and dividends) was $5.1 billion in 2016, up moderately from $4.4 billion in 2015. Fitch expects FCF to decline modestly in 2017 due to a sizable increase in dividends despite capital expenditures returning to normalized levels.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the ratings for BA and BCC as follows:

Boeing Company
—Long-term IDR at ‘A’;
—Senior unsecured debt at ‘A’;
—Bank facilities at ‘A’;
—Short-term IDR at ‘F1’;
—Commercial paper programs at ‘F1’.

Boeing Capital Corporation
—Long-term IDR at ‘A;
—Senior unsecured notes at ’A’.

The Rating Outlook is Stable.