Moody’s Shifts Aerospace and Global Defense Outlook to Negative
MAR 24, 2020 - 6:55 am
Moody’s shifted its outlook for the aerospace and defense sector to negative. This outlook reflects expectations for the fundamental business conditions in the sector over the next 12 to 18 months.
Moody’s changed the outlook for the global aerospace and defense industry to negative from stable. The uncertain duration and spread of the coronavirus outbreak has led to deep capacity cuts and financial stress for passenger airlines.
Moody’s expects airlines and aircraft lessors to delay deliveries of commercial aircraft to lessen the strain on their balance sheets. There is also the potential for weaker passenger demand following the crisis.
Moody’s also changed the outlook for the passenger airline industry to negative from stable on March 6, 2020. The outlook for the global aerospace and defense sector had been stable since December 2019 after having been positive for the preceding four years.
The rapid and widening spread of the coronavirus outbreak is creating a severe and extensive credit shock. The deteriorating global economic outlook, relatively low oil prices and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented.
There will be widespread deferrals of commercial deliveries in 2020. From a regionally contained outbreak, the virus has rapidly spread to become a global crisis, severely denting air travel. Moody’s expects airline passenger volumes to fall by 25% to 35% in 2020 from 2019, with deep reductions and full or partial aircraft groundings during the second quarter of the year.
The duration and severity of the outbreak is uncertain, and Moody’s also model deeper downside scenarios, with risks of extended groundings beyond the second quarter. There is even the potential for the virus to recur later in 2020 or in 2021.
Moody’s expects most of the airlines and lessors requesting deferrals to reach agreements with Airbus SE (A2 stable) and Boeing (The Boeing Company, Baa1 review for downgrade) to defer aircraft deliveries in 2020 and possibly beyond. This will result in another year of severely curtailed deliveries, and one that is much more widespread than 2019’s 737 MAX-driven narrow-body halt.
Moody’s expects passenger demand to recover eventually but airlines’ damaged balance sheets will hurt demand for new aircraft. The timing of recovery remains highly uncertain, but we expect an eventual return to above GDP growth rates. Growth in passenger demand may not recover fully or immediately to long-term trend levels because of potential recessionary effects and the possibility that corporate travel remains permanently impaired. Weaker airline balance sheets are likely to cause lower demand for new aircraft for several years. Moody’s expects Airbus and Boeing to lower production rates, with effects spread throughout the commercial aerospace supply chain.
The defense sector is more robust but unlikely to emerge unscathed. The crisis is likely to lead to significant increases in government borrowing to fund spending programs intended to alleviate pressures on companies and individuals and stimulate economies. This will probably pressure defense budgetary growth. While the sector is supported by the critical long-term strategic nature of many programs, fiscal constraints on budgets are likely to force trade-offs on spending priorities. With many next generation R&D programs expanding along with system modernization broadly, the viability of legacy platforms that consume substantial maintenance funds and other less critical expenditures, potentially focused on IT services, could be reduced.
Measures to contain the coronavirus are likely to disrupt factory production. There are temporary shutdowns of manufacturing capacity across Europe, including Airbus and its supply chain. Utilization in U.S. plants is varied but scaled-down operations and employee furloughs are increasingly becoming the norm.
While the State of California has restricted manufacturing operations, the aerospace industry has been exempted, at least for now. The disruption is likely to put severe strain on smaller suppliers with lower liquidity, absent funding from governmental support programs, including loan programs or guarantees.
Commercial aerospace parts makers and aftermarket services will be directly affected by slowing airframer production rates, steep reductions in flight hours and airline shifts to preserve capital.
Moody’s expects widespread government support, but investors may need to share the pain. Moody’s expects state intervention across a wide range of affected industries, although the nature of such support remains uncertain. The strategic importance of the aerospace industry and its large workforce will make it a priority for government action. Boeing has stated that it is in favor of a proposed $60 billion aid package, including loan guarantees, for the US aerospace industry. We believe there will be conditions to any support, including guarantees of employment levels, suspension of dividends and share repurchases, super-priority claims and/or security provisions. Investors may be required to defer interest payments and become subordinated to higher-ranking debt or face more immediate impairment of their claims.
The aircraft financing market will soften but remain accessible for higher-quality airline credits. We expect the aircraft leasing market to remain open, although lessors will be hurt by intense pressures on airlines. Lessors are being inundated with requests for suspension of rental payments. Lessors will grant these requests for more creditworthy lessees, though with amendments to recapture the near-term loss of rental income. Lower credit-quality lessees will likely see repossessions, increasing the supply of aircraft available for lease relative to near-term demand.
Industry outlooks reflect Moody’s view of fundamental business conditions for an industry over the next 12-18 months. Since outlooks represent a forward-looking view on business conditions that factor into Moody’s ratings, a negative (positive) outlook suggests that negative (positive) rating actions are more likely on average. However, the industry outlook does not represent a sum of upgrades, downgrades or ratings under review, or an average of the rating outlooks of issuers in the industry, but rather our assessment of the main direction of business fundamentals within the overall industry.
Credit and the Coronavirus
The rapid and widening spread of the coronavirus outbreak, the deteriorating global economic outlook, falling oil prices and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented.
Moody’s expects that credit quality around the world will continue to deteriorate, especially for those companies in the most vulnerable sectors that are most affected by prospectively reduced revenues, margins and disrupted supply chains.
At this time, the sectors most exposed to the shock are those that are most sensitive to consumer demand and sentiment, including global passenger airlines, lodging and cruise, autos, as well as those in the oil & gas sector most negatively affected by the oil price shock. Lower-rated issuers are most vulnerable to these unprecedented operating conditions and to shifts in market sentiment that curtail credit availability. Moody’s will take rating actions as warranted to reflect the breadth and severity of the shock, and the broad deterioration in credit quality that it has triggered.
For more information on research on and ratings affected by the coronavirus outbreak, please see moodys.com/coronavirus.
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