DBRS Morningstar Downgrades Ratings on Babcock International Group PLC to BBB (low), Stable

DBRS Ratings Limited (DBRS Morningstar) downgraded the Issuer Rating and Senior Unsecured Debt rating of Babcock International Group PLC (Babcock or the Company) to BBB (low) from BBB. The trends are Stable. The ratings downgrade reflects Babcock’s deteriorating financial profile and DBRS Morningstar’s view that the Company’s financial metrics are no longer commensurate with a BBB rating for the foreseeable future. Both in F2021 and in F2022 so far, the added costs and complexity of operating during the Coronavirus Disease (COVID-19) pandemic have adversely affected Babcock’s operations and profitability. While Babcock has been proactively addressing these issues, a high level of uncertainty remains and any meaningful improvements in both profitability and leverage are likely not going to materialise until at least F2023.

The nature of Babcock's business—supporting nondiscretionary defence, emergency services, and nuclear power programmes and services—ensures that the majority of the Company's work can continue throughout the coronavirus pandemic, with employees designated as critical workers by governments in the UK and internationally. However, while lower levels of demand may affect some areas, the necessary safety constraints imposed by the pandemic such as social distancing and other measures are having a material impact on costs and efficiency, causing Babcock's margins and profitability to weaken significantly. Against this backdrop, the Company and its new management team are proactively addressing these issues with mitigating measures, such as GBP 400 million of expected disposals in noncore assets; the cancellation, for the second year in a row, of dividends; and restructuring measures. DBRS Morningstar positively notes that Babcock has already formally announced nearly three-quarters of the GBP 400 million proceeds in disposals to date.

DBRS Morningstar notes that Babcock’s business risk profile has migrated toward the BBB (low) rating category, but still remains supported by (1) the Company’s strong market position in all its business segments, particularly in the UK; (2) solid track record in winning contracts, with an above-90% success rate in rebids and 40% in new bids; (3) high revenue visibility thanks to its large contract backlog (approximately 2.0 times (x) its revenue in F2021) and because the majority of its contracts are of long duration; and (4) its positioning to benefit from the increasing outsourcing trend for service work at both public- and private-sector entities. However, the coronavirus pandemic has led to increased costs and, along with recent management review, has brought to light inefficiencies, some of which may continue for longer than currently anticipated.

DBRS Morningstar notes that Babcock’s financial risk profile significantly weakened in F2021 and that, while the business environment in calendar year 2021 has been improving, the level of uncertainty remains very high in light of new coronavirus variants and uneven vaccine rollouts globally. As such, DBRS Morningstar anticipates debt-to-EBITDA to be well above 3.0x and cash flow-to-debt below 20% until at least F2023. These levels are not commensurate with an investment-grade financial profile.

Due to the current macroeconomic environment and risk factors discussed above, DBRS Morningstar considers a rating upgrade to be unlikely in the short term. On the other hand, while unlikely at the moment, DBRS Morningstar may consider a rating downgrade if a more severe-than-anticipated downturn occurs, caused by a much longer recovery out of the coronavirus pandemic among other things, or if the Company’s business and financial risk profiles deteriorated further from their current levels.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal methodology is Rating Companies in the Services Industry (29 January 2021), https://www.dbrsmorningstar.com/research/372947/rating-companies-in-the-services-industry, which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021), https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for these ratings include the Company’s annual report, management presentation, financial projections, and budget. DBRS Morningstar considers the information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/384267.

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Amaury Baudouin, Vice President
Rating Committee Chair: Charles Halam-Andres
Initial Rating Date: 7 February 2011
Last Rating Date: 16 September 2020

DBRS Ratings Limited
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Registered and incorporated under the laws of England and Wales: Company No. 7139960

-- Rating Companies in the Services Industry (29 January 2021),
https://www.dbrsmorningstar.com/research/372947/rating-companies-in-the-services-industry.
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021),
https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com.