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Sector
Industrials
Size
Mid Cap
Market Cap £2.12bn
Enterprise Value £3.11bn
Revenue £6.59bn
Position in Universe 133rd / 1913

Fitch Rates Downer's Proposed JPY Medium-Term Notes 'BBB(EXP)'

Mon 28th May, 2018 6:08am
(The following statement was released by the rating agency)


Fitch Ratings-Sydney-May 28: Fitch Ratings has assigned Downer Group Finance Pty 
Limited's (Downer Finance) proposed JPY10 billion fixed-rate medium-term notes 
(MTNs) due 30 May 2033 an expected rating of 'BBB(EXP)'. The issuance is part of 
Australia-based Downer EDI Limited's (Downer, BBB/Stable) debt refinancing, 
which includes the outstanding debt and bonding facilities of Spotless Group 
Limited after Downer acquired a controlling stake in 2017.

The planned notes (ISIN: XS1824467184) will be issued under Downer Finance's 
AUD1 billion debt issuance programme. The final rating is contingent upon 
receipt of the final documentation conforming materially to information already 
received, and details regarding the amount.

The notes will be unconditionally, jointly and severally guaranteed by Downer 
and its subsidiaries currently representing at least 90% of the group's 
consolidated total tangible assets and EBIT. As a result of the guarantee 
structure, Fitch regards the credit risk associated with the notes to be the 
same as that of the senior unsecured obligations of Downer.

KEY RATING DRIVERS

Spotless Improves Diversification: Downer's Spotless acquisition continued its 
portfolio transformation away from the cyclical mining and engineering, 
construction and maintenance sectors towards the infrastructure and civil 
sectors. The service segments' contribution rose to around 86% of total group 
revenue in the year ended June 2017 (FY17) on a pro-forma basis, from 69% in 
FY14 for Downer on a standalone basis. The acquisition also created the largest 
diversified-services group in Australia and New Zealand, which can offer 
end-to-end service capabilities. The combined group's work-in-hand rose to 
AUD39.2 billion by end-2017 from AUD22.5 billion in FY17 for Downer alone.

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 intends to enhance Spotless's risk-management capabilities 
and major bid approval processes but there is no evidence of this enhanced 
oversight across Spotless given the early stages of integration.

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 AUD10.9 billion in lifetime revenue within 
the contract portfolio at end-2017, 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 volatility 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. In FY17, 58% of Downer's total revenue was government related. Fitch 
expects this to fall marginally to around 55%, including the Spotless business, 
which derives around 50% of its facility services revenue from 
government-related entities. We continue 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), which is counterbalanced by 
LafargeHolcim's exposure to the inherently cyclical building-materials sector. 
LafargeHolcim's geographical 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

- FY18 financial performance broadly in line with guidance of underlying net 
profit after tax and before amortisation of acquired intangible assets (NPATA) 
of AUD295 million before minority interests

- Revenue growth from FY19 to FY21 above general forecasts for the Australian 
economy as Downer continues to benefit from increased investment in public 
infrastructure in Australia (2017 Australian GDP growth: 2.4%; Fitch forecast 
revenue growth FY19: 4.8%; FY20: 4.2%; FY21: 4.0%)

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

- Capex to increase to around AUD430 million in FY18f, from around AUD240 
million in FY17, before moderating to around AUD330 million per year from FY19 
to FY21

- Dividend payout ratio between 50%-60% of consolidated underlying NPATA. 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 
elevated leverage from the Spotless acquisition, as well as its 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 (FY17: 2.4x).

- EBITDA margin falling below 6% for a sustained period (FY17: 6.5%).

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. Downer has extended its average debt 
duration following the refinancing of its AUD200 million syndicated loan due 
April 2019, now consisting of two tranches each of AUD200 million due in April 
2022 and 2023. The issuance of the proposed 15-year bullet fixed-rate yen MTNs 
will further extend Downer's average debt duration. Spotless's average debt 
duration has also been extended following the completion of its refinancing to 
more than three years, from 1.8 years at 27 November 2017.

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

Date of Relevant Rating Committee: 15 March 2018

Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: 
leslie.tan@fitchratings.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Corporate Rating Criteria - Effective from 7 August 2017 to 23 March 2018 (pub. 
07 Aug 2017)

https://www.fitchratings.com/site/re/901296

Non-Financial Corporates Hybrids Treatment and Notching Criteria - Effective 
from 27 April 2017 to 27 March 2018 (pub. 27 Apr 2017)

https://www.fitchratings.com/site/re/896881

Non-Financial Corporates Notching and Recovery Ratings Criteria - Effective from 
21 December 2017 to 23 March 2018 (pub. 21 Dec 2017)

https://www.fitchratings.com/site/re/914144

Additional Disclosures 

Solicitation Status 

https://www.fitchratings.com/site/pr/10031970#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

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