Fitch: Airbus Shows Gulf Between Commercial, Defence Segments

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Feb 27 (Reuters) - (The following statement was released by the rating agency)

The widening gulf between the commercial aerospace and defence end markets is highlighted by Airbus Group (Berlin: AIR.BE - news) 's improved 2013 earnings and Fitch Ratings' expectations of further earnings growth in 2014. Companies with exposure to US defence spending will see revenue from this source fall in 2014, while rising commercial aircraft deliveries are expected to boost the commercial arms of major contractors. Nevertheless, no rating actions are expected to stem from these dynamics alone.

For most EMEA-based companies with US-based defence activities, such as Rolls-Royce, MTU Aero Engines (Other OTC: MTUAY - news) or GKN Holdings, the portion of revenue and earnings derived from this market is limited, at around 10% of their group totals. These respective shares have been declining for two years, and we expect further falls again in 2014 as the US continues to lower its defence spending in areas affecting these companies. For BAE Systems, the European company with the greatest exposure to the US defence sector, this portion is now around a third, down from over 40% two years ago, and likely to be around 30% in 2014.

We estimate that in 2014, these four companies will see revenue and earnings from US based defence operations drop by between 5% and 15%. Clarity over the outlook has been provided by the US budget passed in January, which includes a 7.5% fall in procurement spending to USD93bn and a 10% drop in research and development funding to USD63bn. Details on specific programme allocation are not yet available, but are unlikely to materially impact current expectations. Nevertheless, we do not expect lower US defence spending in itself to result in downgrades for any EMEA-based aerospace and defence companies. This is because of their generally broad geographic diversification and, BAE apart, their exposure to buoyant commercial aerospace markets. In the case of BAE, as these cuts were broadly anticipated, it has reduced its operating footprint in the US in recent years to protect profit margins.

In contrast, the demand outlook for commercial aerospace remains positive, with both Airbus and Boeing (NYSE: BA - news) exhibiting strong order books and recently announcing rising production rates. Companies such as Rolls-Royce and MTU also stand to benefit from this owing to their positions as major suppliers to commercial aircraft programmes.

Despite this anticipated growth in the commercial sphere, rating profiles are not expected to change materially in the short to medium term as a result of market dynamics. Rating actions are likely to be driven by company specific factors such as programme execution, core cash generation and cash deployment.

Airbus, which has very limited exposure to US defence, reported a 5% rise in revenue and a 10% lift in EBITDA for 2013 and is expected by Fitch to show similar growth in 2014. This contrasts with BAE, which recently revealed only a mild rise in revenue and earnings for 2013 and is expected to see both revenue and earnings decline in 2014 chiefly as a result of the reduction in US defence spending.