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Sector
Industrials
Size
Mid Cap
Market Cap £2.20bn
Enterprise Value £3.20bn
Revenue £6.70bn
Position in Universe 132nd / 1907

Fitch Affirms Downer at 'BBB'; Outlook Stable

Fri 14th September, 2018 5:14am
(The following statement was released by the rating agency)


Fitch Ratings-Sydney-September 14: Fitch Ratings has affirmed Downer EDI 
Limited's Long-Term Issuer Default Rating and senior unsecured rating at 'BBB'. 
The Outlook on the IDR is Stable. The affirmation also applies to all senior 
unsecured debt issued or guaranteed by Downer, including debt issued by 
subsidiary Downer Group Finance Pty Limited.

The affirmation reflects Downer's strong work-in-hand (WIH), which remains 
supported by the Australia-based company's increasing infrastructure exposure in 
its legacy businesses and the successful integration of Spotless Group Limited's 
business to date.

Downer's financial profile has improved after the Spotless acquisition and 
despite the underperforming contract at the Royal Adelaide Hospital identified 
in the financial year ended 30 June 2018 (FY18). The company's adjusted net 
debt/EBITDAR ratio (leverage) of 2.2x at FYE18 continues to highlight the 
resilience of Downer's businesses and cash generation ability, which the company 
has reported at over 88% of EBITDA for the past seven years.

KEY RATING DRIVERS

Pivot to Service Revenue Continues: Downer's Spotless acquisition has continued 
its portfolio transformation away from the cyclical mining and engineering, 
construction and maintenance sectors towards the infrastructure and civil 
sectors. Segments excluding mining, which are predominantly service-based, made 
up around 89% of total group revenue in FY18, up from around 69% in FY14 for 
Downer on a standalone basis. The combined Downer group is the largest 
diversified-services group in Australia and New Zealand, which can offer 
end-to-end service capabilities. The group's WIH increased to AUD42 billion at 
FYE18 from AUD39.2 billion at end-2017 or AUD22.5 billion at FYE17 for Downer 
only.

Spotless Integration Risk: Fitch believes Downer's strong record in integrating 
newly acquired companies - most recently following the 2014 acquisition of Tenix 
- and executing business turnarounds reduces execution risk around the 
integration of Spotless. Downer's actions to date include performing a 
comprehensive review of Spotless's operations and financial position and the 
integration of a number of key business operations, including the creation of a 
joint bidding committee.

We understand Downer continues to work on enhancing Spotless's risk-management 
capabilities and major bid approval processes. The group reported a cash flow 
conversion of over 90% of EBITDA in FY18 despite the negative cash impact of 
Spotless's 30-year Royal Adelaide Hospital contract, including cash conversion 
of around 92% in the Spotless business excluding the contract. In our view, this 
highlights Downer's ability to successfully integrate companies into its system. 
However, we have not seen evidence of enhanced oversight on bidding to date 
given the early stages of integration.

Separate Financial Management: Downer continues to manage the financing of its 
legacy operations and the Spotless business separately, with no guarantees 
between the two entities, as it was only able to acquire around 88% of Spotless. 
The Spotless business had AUD833 million in debt outstanding at FY18. In our 
view, this creates some structural subordination for the creditors of Downer as 
cash generated at Spotless will be applied first to the debt outstanding at that 
entity. However, this structural subordination has no impact on the ratings in 
light of the size of Spotless's EBITDA contribution to the combined group.

High Earnings Visibility: The group's earnings visibility has been bolstered by 
the Spotless acquisition. Around 85% of Spotless's revenue is contracted, with 
tenures typically between three and five years. Spotless had public-private 
partnership-related contracts worth around AUD11 billion in lifetime revenue 
within the contract portfolio at FYE18 (end-2017: AUD10.9 billion), with tenures 
typically between 25 and 30 years. The inclusion of these long-term stable 
contracts in the group's order book complements Downer's improved earnings and 
cash flow visibility as its project-mix transitions towards more regular, lower 
risk, less capital intensive and maintenance-type work.

Focus on Government Spending: Government-related revenue has increased as a 
proportion of Downer's total revenue base, as the Australian economy shifts away 
from the resources sector and the government prioritises infrastructure 
spending. The acquisition of Spotless has diluted this marginally, however Fitch 
continues to expect government infrastructure spending to be the primary source 
of major new opportunities for the combined Downer group over the medium term.

Robust Project-Risk Oversight: Downer's robust project bidding and execution 
skills will become increasingly important as competition intensifies across all 
sectors. Downer's senior management is directly involved in monitoring the 
bidding and delivery of all major projects to identify potential problems and 
avoid major cost overruns. Downer has implemented an approval process and 
changed Spotless's risk-management capability following its acquisition, which 
we view as positive to the newly formed group's risk profile.

Further M&A Detrimental: Additional large, debt-funded M&A may pressure Downer's 
rating at a time when it has little headroom within its negative rating 
guidelines. However, we do not expect significant M&A in the short term, as 
Downer remains focused on integrating Spotless and taking advantage of any 
opportunities the acquisition provides.

DERIVATION SUMMARY

Downer's scale and diversification across sectors have improved following its 
Spotless acquisition. However, the combined group is still smaller and less 
geographically diversified than major global peers, including Vinci S.A. 
(A-/Stable), accounting for the two-notch differential. 

Downer has lower leverage than LafargeHolcim Ltd (BBB/Stable), while 
LafargeHolcim has exposure to the inherently cyclical building-materials sector. 
However, LafargeHolcim's geographic diversification provides some cash flow 
stability to the volatility in its sector, and combined with its stronger 
profitability, leads us to rate them at the same level. 

Ferrovial, S.A. (BBB/Stable) is among the top Fitch-rated engineering and 
construction companies. However, its construction margins are under pressure and 
its UK services business is being weighed down by uncertainty in the country. 
Notwithstanding these challenges, which are in stark contrast to the favourable 
environment in Australia, Spain-based Ferrovial has a conservative balance sheet 
and hence both companies are rated at the same level.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Revenue growth in FY19 to be generally flat, reflecting lower opening WIH in 
Utilities and E,C&M. Revenue growth from FY19 to FY22 above Fitch forecasts for 
the Australian economy as Downer continues to benefit from increased investment 
in public infrastructure in the country (FY20: 3.7%; FY21 and FY22: 3.4%).

- Project delivery governance to remain in place with no further major 
write-offs not already publicly disclosed.

- Capex to moderate to around AUD330 million per year from FY19 to FY21.

- Downer dividend payout ratio between 50% and 60% of consolidated underlying 
net profit after tax and amortisation. No dividends to be paid at Spotless.

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating 
Action

- No positive rating action is anticipated over the medium term due to Downer's 
geographic concentration and scale.

Developments That May, Individually or Collectively, Lead to Negative Rating 
Action

- Adjusted net debt/operating EBITDAR rising to above 2.5x for a sustained 
period (FY18: 2.2x)

- EBITDA margin falling below 6.0% for a sustained period (FY18: 6.2%)

LIQUIDITY

Adequate Capital Market Access: Downer has access to a wide range of funding 
sources, including syndicated loans, capital market debt and equity. Downer will 
continue to manage each entity's debt on a standalone basis, as it was unable to 
complete a 100% takeover of Spotless. It also conducted a detailed review and 
refinance of Spotless's debt and bonding facilities as part of its refinancing 
of the group's facilities in 2H18. Following the refinance, the group's 
weighted-average debt duration increased to four years at FYE18 from 2.3 years 
at 1HFYE18, including the issuance of a 15-year yen-denominated bond.

Contact: 

Primary Analyst

Kelly Amato, CFA

Director

+61 2 8256 0348 

Fitch Australia Pty Ltd

Level 15, 77 King Street, Sydney, 

NSW, 2000 Australia

Secondary Analyst

Leo Park

Associate Director

+61 2 8256 0323 

Committee Chairperson

Vicky Melbourne

Senior Director

+61 2 8256 0325

Media Relations: Leslie Tan, Singapore, Tel: +65 6796 7234 , Email: 
leslie.tan@fitchratings.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Corporate Hybrids Treatment and Notching Criteria (pub. 27 Mar 2018)

https://www.fitchratings.com/site/re/10024296

Corporate Rating Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10023785

Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10024585

Sector Navigators (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10023790

Additional Disclosures 

Dodd-Frank Rating Information Disclosure Form 

https://www.fitchratings.com/site/dodd-frank-disclosure/10044700

Solicitation Status 

https://www.fitchratings.com/site/pr/10044700#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

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