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I AGREE
26 Jun 2018
Frankfurt am Main, June 26, 2018 -- Moody's Investors Service, (Moody's) has today downgraded
the corporate family rating (CFR) of the German defense manufacturing
company H&K AG (Heckler & Koch) to Caa1 from B3 and the probability
of default rating (PDR) to Caa1-PD from B3-PD. The
rating outlook has been changed to negative from stable.
"Our decision to downgrade Heckler & Koch's rating reflects
the company's weak liquidity profile and very high leverage.
The group's liquidity has deteriorated markedly in the first five
months of the year despite shareholders contributing EUR 30 million to
the company in the form of a shareholder loan early 2018. As of
May 2018 Heckler & Koch had EUR 27.8 million unrestricted cash
on balance, a reduction of around EUR 20 million YTD May 2018 (excluding
the EUR 30 million shareholder loan). The group's weak liquidity
profile is further exacerbated by the material risk of breaching the SFA
covenant at the end of June 2018. The group's Moody's
adjusted leverage ratio deteriorated to 9.4x at the end of 2017
(6.2x in 2016) as a result of a 37.9% decline in
EBITDA and despite EUR 50 million equity increase and successful debt
refinancing in 2017. While the company expects EBITDA this year
to recover, in the first four months of 2018 it was down 60%
compared to the same period last year" says Vitali Morgovski, a
Moody's Assistant Vice President-Analyst and lead analyst for Heckler
& Koch.
RATINGS RATIONALE
Today's downgrade reflects a significant deterioration in Heckler
& Koch's liquidity profile. By the end of Q1 2018 liquidity
was down to EUR 10.9 million and in April 2018 the company was
supported by a EUR 30 million interest-free loan from its shareholders.
While this has improved the amount of unrestricted cash available,
Moody's sees a risk of a further decline to below EUR 20 million
in the coming few months, which in Moody's view represents
a minimum required amount to run the company's day-to-day
business. In light of the company's weak performance we see
a risk of further covenant breach at the end of Q2 2018, which would
require further support from the shareholders to obtain an equity cure
or similar.
Today's action also reflects the weakness in earnings and cash generation
in the second half of 2017 that continued in the first few months of 2018.
Revenue and EBITDA last year were down 10% and 37.9%,
respectively, due to delays in product deliveries caused by the
implementation of a new concept for production and assembly lines in Oberndorf,
Germany. This led to an increase in Moody's adjusted leverage
ratio to 9.4x at the end of 2017 from 6.2x in 2016.
Moody's expects that the company's leverage will deteriorate
further during 2018 to more than 10x. The new product introduction
(VP9SK pistols) for the US commercial market also occurred later than
expected and the overall demand in the US commercial market was weaker
in 2017. At the same time the company is bearing additional costs
of construction of a new manufacturing facility in the US. Furthermore,
problems with SAP system for order processing additionally delayed product
deliveries.
These issues have not been completely resolved this year. While
revenue is starting to show an improving trend and is currently up year-on-year,
EBITDA is yet to recover and was down 60% in the first four months
of 2018 compared to the same period last year. Operating cash flow
was negative so far this year and free cash flow was naturally more so.
Moody's views a material risk that Heckler & Koch will not be
able to achieve its budget in 2018, even assuming a recovery in
the second half of the year.
While the company is obviously facing some serious operating challenges
at present, its competitive position on the market remains strong,
reflected in solid order backlog and increasing order intake. In
2017 Heckler & Koch's order intake increased by 1.6%
y-o-y and given the delayed deliveries its order backlog
(excluding orders for which export licenses are not expected to be granted)
rose by 25% by the end of the year to EUR 156 million, which
corresponds to around ¾ of H&K's annual sales.
Year-to-date order intake developed even better, rising
40% y-o-y through May.
Moody's positively acknowledged a successful refinancing of H&K's
EUR 220 million notes with EUR 130 million SFA due 2022 and EUR 60 million
Senior Notes due 2023 complemented by a EUR 50 million equity injection
in 2017. As a result group's reported gross debt declined
from EUR 220 million in 2016 to EUR 182 million in 2017 and its interest
expense should be approximately EUR 8 million lower in 2018 compared to
the previous year. Additionally, the company was able to
agree a covenant amendment (on leverage ratio and minimum cash level)
with lenders in its SFA facility that it otherwise would breach given
a substantial decline in EBITDA.
RATIONALE FOR NEGATIVE OUTLOOK
The negative outlook reflects Moody's view that there is a material
risk of leverage ratio (Moody's adjusted) remaining at the current
elevated level, well in excess of 8x, even in case of recovery
in the second half of 2018. Furthermore, Moody's understands
that the covenant headroom in SFA facilities in Q2 and Q3 this year will
be very low and the amount of unrestricted cash on the balance sheet could
continue to decline as we do not expect H&K to generate positive FCF
this year.
WHAT COULD MOVE THE RATINGS - UP
• Positive FCF generation supporting company's liquidity such that
it increases to in excess of EUR 25 million on a sustainable basis
• Expectations that Moody's adjusted gross debt/EBITDA will remain
sustainably below 6.5x
• Tender wins and no material contract losses, to ensure the
company's earnings sustainability.
WHAT COULD MOVE THE RATINGS -- DOWN
• Eroding liquidity such that the amount of unrestricted cash trends
towards EUR 10 million,
• Moody's adjusted gross debt/EBITDA sustainably above 8x
Liquidity
Moody's views Heckler & Koch's liquidity as weak.
Operating issues also affected company's unrestricted cash position
on the balance sheet that declined to EUR 18.7 million at the end
of 2017 (EUR 20.8 million in 2016). By the end of Q1 2018
liquidity was down to EUR 10.9 million and the company was supported
by an interest-free loan from its shareholders. While this
has improved the amount of unrestricted cash to EUR 27.8 million
at the end of May 2018, Moody's sees a risk of a further decline
to below EUR 20 million in the coming few months, which in Moody's
view represents a minimum required amount to run company's day-to-day
business. While EUR 30 million revolving credit facility was available
to Heckler & Koch in the past, the company no longer has access
to this RCF, as it was not extended last year. Furthermore,
we see a material risk of breaching the covenant at the end of June and
September 2018. While H&K has an equity cure option,
it would require further liquidity injection from its shareholders.
PROFILE
Headquartered in Oberndorf, Germany, Heckler & Koch is
a leading, privately-owned defense contractor in the small
arms sector. Heckler & Koch predominantly supplies the armed
forces of NATO and NATO equivalent countries, European and US Special
Forces, European police forces and US federal law enforcement agencies.
The company also serves the commercial market. It designs,
produces and distributes small arms, including rifles, side
arms, sub-machine guns, machine guns and grenade launchers,
as well as a variety of other related products & services.
In 2017 Heckler & Koch generated sales of EUR 182 million and reported
EBITDA of EUR 30 million.
PRINCIPAL METHODOLOGY
The principal methodology used in these ratings was Aerospace and Defense
Industry published in March 2018. Please see the Rating Methodologies
page on www.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the credit rating action on the support provider and in relation to
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credit ratings from the support provider's credit rating.
For provisional ratings, this announcement provides certain regulatory
disclosures in relation to the provisional rating assigned, and
in relation to a definitive rating that may be assigned subsequent to
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respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit
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the associated regulatory disclosures will be those of the guarantor entity.
Exceptions to this approach exist for the following disclosures,
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to rated entity, Disclosure from rated entity.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
Vitali Morgovski
Asst Vice President - Analyst
Corporate Finance Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Matthias Hellstern
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
No Related Data.
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