Broadspectrum Ltd. Rating Raised To #BB+# And Removed From CreditWatch Outlook Is Stable

Stocks and Financial Services Press Releases Friday July 29, 2016 19:11
MELBOURNE--29 Jul--S&P Global Ratings

MELBOURNE (S&P Global Ratings) July 29, 2016--S&P Global Ratings said today that it had raised its corporate credit rating on Australian services company Broadspectrum Ltd. (Broadspectrum) to 'BB+', from 'BB'. The outlook isstable.

At the same time, we raised our ratings on the company's senior secured debt to 'BBB-', from 'BB+'; and on the senior unsecured debt to 'BB-', from 'B+'. We also removed all ratings from CreditWatch with positive implications, where they were placed on May 3, 2016. The recovery ratings remain unchanged at '2' for the company's senior secured debt and '6' for its senior unsecured debt.

The upgrades reflect our view of the implied support from Broadspectrum's sole parent—Ferrovial S.A., a Spanish services and construction company with revenues of €9.2 billion in 2015. We assess Broadspectrum as a moderately   strategic subsidiary to Ferrovial.

"We believe that the acquisition   enhances the geographic diversification of Ferrovial's business service activities, given Broadspectrum's good presence in the Australian defense and infrastructure sectors. It will also provide Ferrovial an entry into new segments such as oil and gas, and telecommunications," said S&P Global Ratings credit analyst May Zhong.

Nevertheless, we believe that Broadspectrum's contribution to Ferrovial's profitability will be limited, due to Broadspectrum's low margins in the local competitive and fragmented market. We have applied a one-notch uplift to the ratings on Broadspectrum to reflect the credit support it receives as a subsidiary of the Ferrovial group.

We continue to assess Broadspectrum's business risk profile as fair, underpinned by its good diversity in terms of end-markets, service mix, and customer base. Tempering these strengths is the competitive and fragmented nature of the operations and maintenance, and facilities management ndustries. Further, the company's EBITDA margin is weaker compared with those of its larger global peers'. With revenues of about A$3.8 billion in the fiscal year ended June 30, 2015, the company is a medium-size provider of operations, maintenance, facilities management, and construction services in Australia.

From a credit perspective, Broadspectrum's distinctive competitive advantage is its diversified contract types, product offerings, and customer base. Contract and revenue concentration is relatively low. The company is actively present in six major industries with more than 250 contracts. The industry diversity insulates the company from a severe downturn in cyclical industries such as mining or oil and gas. Nonetheless, despite its diversified revenue and contracts, we estimate that its contracts with the Department of Immigration and Border Protection (DIBP) to provide welfare and garrison support services at the Regional Processing Centres in Nauru and Manus Province currently account for a disproportionally large percentage of Broadspectrum's earnings in fiscal 2016. When these contracts expire in 2017, it could materially reduce the company's earnings unless they are replaced by new revenue streams with high margins.

In our view, Broadspectrum operates in an industry with relatively low capital intensity and low barriers to entry, leading to fragmented markets and price competition. We view Broadspectrum's consolidated EBITDA margin of 8% as relatively modest, reflecting the competitive nature of the industry and Broadspectrum's high overhead costs. Nonetheless, its EBITDA margin varies among different end-markets and service types, from being in the high teens in defence, social and properties, to the low single digits in resources and industrial. Its EBITDA margin continues to be at a cyclical high in fiscal 2016 due to the benefits of the high-margin immigration contacts with DIBP. We expect its earnings and margin to fall in fiscal 2018 when these contracts expire. We believe the company will actively pursue new earnings streams to replace the immigration contracts.

Broadspectrum's significant financial risk profile reflects its ratio of funds from operations (FFO) to debt being in the 20%-30% range, and debt-to-EBITDA between 2.0x and 3.0x. A key strength of its financial risk profile is its strong free cash flow generation, which we believe is due to the low capital-expenditure requirement of the services industry. We therefore expect the company's discretionary cash flows to be positive, such that its adjusted debt could reduce steadily from peak levels in fiscal 2015.

Ms. Zhong added: "The stable outlook reflects our expectation that Broadspectrum will maintain its key credit metrics such that its adjusted FFO to debt will be higher than 20% and adjusted debt to EBITDA below 3x over the next few years, despite the material fall in earnings when the immigration contracts with DIBP expire in 2017. However, the likely large fall in earnings would reduce the rating buffer and leave limited room for underperformance until replacement earnings streams are established."

We could consider raising the rating if Broadspectrum adopts more-conservative financial risk policies while pursuing growth opportunities. This would be evident if adjusted debt-to-EBITDA (including operating lease obligations) remains low at around 2x and its lease-adjusted FFO-to-debt ratio remains at more than 30%.

We may also raise the ratings if there is a track record of long-term commitment from the parent's senior group management or we observe a closer linkage between the parent and Broadspectrum over the next 18-24 months.

Downward rating movement could occur if Broadspectrum's key credit metrics weaken materially, for example its FFO-to-debt ratio worsening to lower than 20%. This could occur if the company is unable to replace the immigration contract with sustainable new revenue streams.

Although we do not consider it likely in the near to medium term, downward rating pressure could also arise if Broadspectrum's strategic importance to Ferrovial weakens, or there is a material deterioration in Ferrovial's credit quality to the speculative-grade level ('BB+' and below).


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