A Rough Haul for European Transport
We at Standard & Poor's Ratings Services believe the outlook for the European transportation industry is less positive in 2006 than in recent years.
In the airline industry, continuing high oil prices, the march of low-cost carriers, and fears of avian flu add up to an uncertain outlook. Prospects for rated shipping companies are gradually deteriorating after a period of good economic conditions encouraged operators to speculatively order new capacity. This could lead to a demand-and-supply imbalance over the next few years.
Meanwhile, although business conditions in the logistics and postal-service sector remain favorable, the ongoing consolidation process could put pressure on operators' financial profiles.
Consolidation and shareholder pressure were the key drivers of rating actions in the European transportation industry over the past few months. Standard & Poor's Ratings Services lowered its corporate credit ratings on Netherlands-based mail, express, and logistics group TNT (S&P credit rating, A-) by one notch, owing to the company's revised financial policy, including concerns over heavier share-buyback programs or acquisitions than afforded by the company's funds from operations.
The outlook on Deutsche Post (A) was revised to negative after the company acquired Britain-based contract logistic and freight-forwarding operator Exel in December, 2005. We're concerned about the group's ability to steadily improve its financial profile after the acquisition.
Liquidity also remains an issue for some companies. The rating on France-based auto logistics provider Global Automotive Logistics (GAL) (B-) was lowered by two notches, owing to increased liquidity concerns and its weak operating performance over the past few months.
However, the rating on Swedish bus services provider Concordia (B-) was raised, due to an improvement in its distressed liquidity position and a moderate strengthening of its weak capital structure, following the conclusion of the group's financial restructuring.
What's S&P's view of rated companies in the sector? Here's our current report card (ratings are as of March 15, 2006):
Mail, Express, & Logistics Companies
Deutsche Post (A)
Deutsche Post's financial profile significantly weakened after the acquisition of Britain-based logistics provider Exel in December, 2005. Credit-protection ratios are expected to remain on a weak level for the rating category over the next quarters, but should gradually improve through profitability improvements in its currently weak U.S. Express division and synergies from recent acquisitions in its Express Europe division.
TNT's financial profile has weakened over the past few months, following share repurchases of about €700 million since December, 2005. We expect the group to soon become structurally more debt-leveraged than previously. Ratings could come under renewed pressure through heavier share-buyback programs or acquisitions than afforded by the company's levels of funds from operations.
Global Automotive Logistics (B-)
GAL continues to faces risk with respect to compliance with its covenants over the next quarters. We have concerns that GAL will not meet mandatory debt repayments in 2006 without additional support from either its banks, shareholders, or other sources. Therefore, the renewal of its major contract with Renault, which expires in 2008, and its ability to achieve a successful financial restructuring are the key rating factors for its future creditworthiness.
Thiel Logistik (B)
Thiel's operating earnings before interest and taxes (EBIT), before exceptional items, is expected to be between €25 million and €30 million for 2005. We don't expect the group to have generated positive free operating cash flow in 2005, as Thiel is unlikely to achieve similar working capital savings to those seen in 2004. Furthermore, we expect cash flow to remain negligible for 2006.
British Airways (BB+)
Improved traffic revenue, particularly from the premium segment, as well as fuel surcharges, allowed British Airways (BAB) to maintain its trend of improving results, despite rising fuel costs. Operating profit rose by 21% in the nine months prior to December 31, 2005.
Revenue growth of more than 8% for the full year to March, 2006, should support profitability and maintain the group's credit profile at current levels. Significant structural changes are planned to mitigate rising costs and provide further momentum to achieve BA's 10% operating margin target. At Dec. 31, 2005, liquidity was satisfactory, reflected by cash and undrawn committed lines of about £2.4 billion.
Deutsche Lufthansa (BBB)
Stronger passenger revenues, cost reductions, and a small operating profit at the previously loss-making catering division helped to strongly improve operating performance for the nine months up to September 30, 2005. Full-year operating profit is expected to rise by more than 40%, to about €550 million. Further cost-cutting is planned to combat strong competition and expected additional fuel costs of between €700 million and €1 billion in 2006. Lufthansa has strong liquidity and should continue to generate free cash flow.
CMA CGM (BBB-)
Industry conditions should remain healthy in the near term, but are expected to deteriorate in the intermediate term as significant new capacity is delivered. This is expected to lead to deteriorating profitability and cash flows for all industry participants in the medium term, including CMA CGM. Operating cash flows for CMA CGM should, however, remain strong in the near term.
Gearbulk Holding (BB)
Gearbulk's financial profile has strengthened over the past few years as a result of the strong market. In November, 2005, however, the company paid an extraordinary dividend of $100 million. Although Standard & Poor's views this as negative, the impact on the financial flexibility is limited and isn't expected to affect any plans to renew the fleet. Pro forma the dividend payment, net debt to capital would have been about 60%, which is still acceptable for the rating, as cash flow is expected to remain strong in the near term.
Ship Finance International (BB-)
Ship Finance has benefited from the strong tanker markets over the past few years, which has led to greatly improved earnings through the company's profit-sharing agreements. Most of these earnings have, however, been distributed to shareholders, and to a lesser extent, invested in new vessels.
Downside risk continues to be mitigated by the fixed contract structure for most of the company's vessels, although its significant exposure to a few non-guaranteed subsidiaries of Frontline (not rated) remains. Liquidity remains strong, backed by a $296 million charter service reserve, which would cover any shortfall in earnings at the Frontline subsidiaries.
Leverage is high for the current ratings. The unadjusted net debt-to-capital ratio was 62% at the end of September, 2005. Nonetheless, Stena continues to invest heavily, which pressures the rating. Earnings from Stena's tanker segment are expected to fall as a result of lower expected tanker freight rates in 2006. Nevertheless, revenues in its drilling business are likely to improve, reflecting buoyant drilling markets. Furthermore, Stena's operating performance should remain relatively stable due to its diversification and the contractual nature of parts of its businesses.
Concordia Bus (B-)
Ratings were raised and removed from CreditWatch on January 13, 2006, to reflect the group's improved liquidity position following its financial restructuring. The group's €160 million subordinated notes were converted to equity in October, 2005. Concordia has been unable to gain adequate compensation for cost variations on a number of its Swedish public bus contracts and will need to strongly improve operating performance over the next 12 months. As of November 30, 2005, liquidity was limited, but adequate for the next 12 months.
Rail continues to perform strongly and to support earnings levels, despite margin reduction from increasing costs in the company's British bus operations. Rising fuel costs are likely to continue to pressure earnings in calendar year 2006.
The group is now the largest rail operator in Britain, following its successful tender for a renewed and enlarged Greater Western rail franchise and after securing the rights to operate the Great Northern/Thameslink rail franchise. As of September 30, 2005, liquidity was adequate, reflected by £243 million of unrestricted cash and available committed lines.
Stagecoach Group (BBB)
Strong performance from rail and increased bus revenues is helping to maintain earnings levels and offset increased fuel and labor costs in the British bus division. Additional fuel costs are expected to pressure bus margins in calendar year 2006. The group relies on one key rail franchise, South West Trains, for about one-third of its operating profits. Stagecoach is competing with three other bidders to renew this franchise, which expires in February, 2007.
As incumbent, the group is in a good position to retain the franchise. Stagecoach's business and credit profile could, however, be weakened if the franchise is lost. As of October 30, 2005, Stagecoach's liquidity was adequate, reflected by £427 million of unrestricted cash and available committed lines.
Brenntag Holding (B+)
Brenntag's leverage increased after the closing of its January, 2006, recapitalization. Pro forma for the recapitalization, total lease- and pension-adjusted debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) is expected to be about 6.0x (or 5.75x unadjusted) for the year ended December 31, 2005. Free operating cash flow is expected to be positive in 2006 and to be used mainly for debt reduction.
Kloeckner & Co. (B+)
Kloeckner will continue to experience a substantial degree of volatility from the fluctuation in metal prices. We expect Kloeckner to continue to generate operating cash flow-to-net debt of about 10% and positive free operating cash flow after working capital and capital expenditures.