Investing.com -- S&P Global Ratings has upgraded the long-term issuer credit ratings of UK-based aerospace and defense group BAE Systems PLC (LON: BAES ) (BAE) to ’A-’ from ’BBB+’ due to record order backlogs and improved credit metrics. The short-term issuer credit rating remains affirmed at ’A-2’.
The credit rating agency anticipates BAE’s top-line to continue its upward trajectory in 2025 and 2026, with steady profitability and positive free cash flow generation. This follows a robust 2024, where healthy order backlogs supported the company’s growth. Consequently, the adjusted debt to EBITDA ratio is projected to be between 1.5x-2.0x in the next two years. The funds from operations (FFO) to debt ratio is also expected to increase from 2024 levels, reaching about 45%-55% in 2025-2026.
S&P Global Ratings predicts that BAE’s free operating cash flow (FOCF) will exceed £4 billion cumulatively over the next two years. This will enable the company to comfortably fund smaller mergers and acquisitions (M&A), a progressive dividend policy, and its share buyback program, while maintaining strong credit metrics.
The stable outlook reflects the expectation that BAE’s revenue will grow to over £28 billion in 2025 and about £30 billion in 2026, with stable adjusted EBITDA margins of approximately 14.5%-14.8%. The FFO to debt ratio is also expected to gradually improve to more than 45% during the same period.
S&P Global Ratings expects BAE’s leverage to gradually improve over 2025-2026. BAE’s FFO to debt ratio is projected to climb above 45% in 2025 and above 50% in 2026, after a dip in 2024 to 43%. This follows the debt-funded acquisition of Ball (NYSE: BALL ) Aerospace & Technologies Corp. The debt to EBITDA ratio is forecasted to be about 1.5x-1.8x over the same period, driven by reducing net debt and rising absolute EBITDA generation. BAE’s S&P Global Ratings-adjusted net debt is expected to be close to £7 billion in 2025 and £6.7 billion in 2026, down from £7.2 billion in 2024.
Despite a slight reduction in BAE’s FOCF in 2024 (£2.5 billion) compared with 2023 (£2.7 billion), it was another strong year of positive free cash flow generation, which is expected to continue in 2025 and 2026. Over the two years, BAE is expected to generate at least £4 billion in FOCF cumulatively. Capital expenditures (capex) in 2025 are expected to increase marginally, to approximately £1.3 billion, compared to £1.16 billion in 2024.
The dividend payout in 2024 totaled just over £1 billion, and BAE is expected to continue its dividend policy of about 2.0x long-term sustainable coverage of underlying earnings. The dividend payment is expected to rise to about £1.1 billion in 2025 and about £1.1 billion-£1.2 billion in 2026. BAE’s most recent share buyback program was announced in July 2024, to repurchase shares in the open market of about £1.5 billion over three years.
BAE’s sales are likely to increase over the medium term, supported by end-market conditions that will continue to drive order-intake to record levels. This has led to BAE’s order backlog increasing to a record £78 billion at the end of 2024. We expect solid growth across all of BAE’s key divisions, leading to an increase in revenues by about 8% in 2025 to approximately £28.4 billion, with similar growth expected in 2026.
Potential mitigants to operating performance could include the effect of tariffs or supply chain disruptions. However, the rate at which the group can deliver these depends on the reliability and availability of key raw materials, parts, and skilled labor. This could potentially slow down the rate at which BAE can deliver on orders, but it is not anticipated to have a major effect on the group’s revenue growth or its profitability profile, as stable margins are expected to continue.
S&P Global Ratings could consider raising the rating on BAE if the group builds a durable track record of an exceptionally strong balance sheet under any market conditions. This would likely involve FFO to debt remaining sustainably above 60% and debt to EBITDA being maintained below 2.0x. An upgrade would also depend on BAE providing a clear financial policy that will support a higher credit standing.
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