(The following statement was released by the rating agency) Fitch Ratings-Sydney-September 12: Fitch Ratings has affirmed Downer EDI Limited's Long-Term Issuer Default Rating and senior unsecured rating at 'BBB'. The Outlook 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) of AUD44.3 billion as at the financial year ending-June 2019 (FY19), which was supported by the Australia-based company's shift towards recurring maintenance style contracts, compared to historically more volatile construction and mining type revenue. We have applied our business-services navigator to reflect this change, which is used to assess issuers that provide outsourcing services to other businesses, such as catering and facilities management, as well as other types of contract-based services that are usually provided on the customer's premises. Downer's facilities business is its only segment that explicitly falls into this sector, but we believe the recurring service-oriented nature of Downer's remaining business has similar attributes to those of peers in this sector and is best reflected by this navigator. Fitch has also amended Downer's rating sensitivity metric to FFO adjusted net leverage from adjusted net debt/EBITDAR with a requisite change in hurdle. We believe this reflects Downer's stable cash generation from its increasingly recurring revenue, with EBITDA cash conversion remaining at over 80% since FY11. We previously used an EBITDAR leverage metric to remove the effects of lumpy cash flow that is typically generated by construction contracts. Downer's financial profile has continued to improve, with FFO adjusted net leverage declining to 2.5x in FY19 (FY18: 2.6x) from a peak of 2.7x after its Spotless acquisition in FY17. We believe this highlights the resilience of Downer's businesses and its cash-generation ability, and we expect the company to further deleverage over the medium term. Key Rating Drivers Long-Term Service Revenue: Downer is Australia's largest diversified-services group that offers end-to-end capabilities in Australia and New Zealand. Downer continues to progress its transformation away from cyclical mining and engineering and construction towards the infrastructure and civil sectors. Segments excluding mining, which are predominantly service-based, made up 89% of total group revenue in FY19, up from 74% in FY14. This shift towards annuity style, lower risk, less capital intensive and maintenance-type work has improved revenue and margin visibility, reducing Downer's overall business risk and has improved its EBITDA cash conversion ratio, which has remained above 80% since FY11 (FY19: 89%).Spotless's Separate Financial Management: Downer separately manages the financing of its legacy operation and its Spotless business, with no guarantees between the two entities, as it was only able to acquire 88% of Spotless. Spotless had outstanding debt of AUD793 million in FY19, which we believe creates some structural subordination for Downer's creditors, as cash generated at Spotless is first applied to debt outstanding at that entity. However, this does not affect Downer's unsecured creditors, with prior-ranking debt of less than 1x group EBITDA. We believe debt at Spotless will continue to decrease. Fitch believes prior-ranking debt of more than 2.0x-2.5x EBITDA may indicate a material possibility of subordination. Focus on Government Spending: Government-related revenue has increased as a proportion of total revenue, as the Australian economy shifts away from the resources sector and the government prioritises infrastructure spending. Fitch continues to expect government infrastructure spending to be the primary source of major new opportunities for Downer group over the medium term.Tighter Project-Risk Oversight: Fitch believes Downer's project bidding and execution skills remain robust, notwithstanding provisions associated with the Murra Warra wind farm. Direct senior management monitors, bids on and delivers all major projects to identify any problems and avoid major cost overruns. We believe the strength of this oversight was demonstrated by the recent renegotiation of the legacy-Spotless contract regarding Royal Adelaide Hospital to limit further losses. Nevertheless, losses on contracts are an inherent business risk, as demonstrated by the AUD45 million provision for Murra Warra project in FY19. We understand that management has addressed the issues with this project and has implemented safeguards to prevent similar occurrences. Potential Mining Disposal Neutral: Downer has flagged that its mining business, which contributed 12%, or AUD77 million, of underling EBIT, is under review, with a view towards a potential sale. Fitch has not included a disposal of the segment in its base case, but expects that it would be neutral to the rating, although it may reduce leverage headroom depending on the use of cash proceeds. A disposal would further shift Downer towards less capital intensive service-based revenue, lowering earning volatility and improving the overall business profile. Derivation Summary Business-services peers are generally in the food and facility-management sectors, which only account for a portion of Downer's business. However, the framework better reflects the recurring service-oriented nature of Downer's business.Downer's scale and diversification across sectors continues to improve, although its international diversification is limited, with revenue largely generated in Australia and New Zealand. This limits its rating to the 'BBB' category. The company's lack of international diversification and smaller scale is reflected in the two notch difference to Compass Group (LON:CPG) PLC (A-/Stable), despite similar financial profiles. Downer's larger scale, greater end-market diversification and lower leverage are reflected in the rating being three notches above that of Elis SA (BB/Stable). No Country Ceiling, parent-subsidiary or operating environment aspects affect the rating. Key Assumptions - Revenue growth of 4.5% in FY20 then 3.0% thereafter. This is above the growth rate that Fitch forecasts for Australia's economy, as Downer will benefit from increased investment in public infrastructure and government spending (FY19: 6.7%).- Project delivery governance to remain in place, with no further major write-offs not already publicly disclosed.- Annual ongoing capital expenditure in line with historical average.- Downer dividend pay-out ratio of between 50%-60% of consolidated underlying net profit after tax and amortisation (FY19: 53%). No dividends paid at Spotless.- No disposal of mining segment. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating ActionNo 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- FFO adjusted net leverage rising to above 3.0x for a sustained period (FY19: 2.5x)- EBITDA margin falling below 6.0% for a sustained period (FY19: 6.2%) Liquidity and Debt Structure Adequate Capital Market Access: Downer has access to a wide range of funding sources, including syndicated loans, local and international capital market debt and equity. Downer continues to manage each entity's debt on a standalone basis, due to minority holdings at the Spotless level. Downer has well-spread debt maturities, with limited maturities due in FY20. It had cash on hand of AUD 711 million and a weighted-average debt duration of 3.6 years in FY19 (FY18: 4.0 years). ESG Considerations Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on our ESG Relevance Scores, visit www.fitchratings.com/esg Downer EDI Limited; Long Term Issuer Default Rating; Affirmed; BBB; RO:Sta ----senior unsecured; Long Term Rating; Affirmed; BBB Downer Group Finance Pty Limited ----senior unsecured; Long Term Rating; Affirmed; BBB Contacts: Primary Rating Analyst James Hollamby, Associate Director +61 2 8256 0347 Fitch Australia Pty Ltd Level 15 77 King Street Sydney NSW 2000 Secondary Rating Analyst Kelly Amato, CFA Director +61 2 8256 0348 Committee Chairperson Vicky Melbourne, Senior Director +61 2 8256 0325
Media Relations: Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com; Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Hybrids Treatment and Notching Criteria (pub. 09 Nov 2018) https://www.fitchratings.com/site/re/10051058 Corporate Rating Criteria (pub. 19 Feb 2019) https://www.fitchratings.com/site/re/10062582 Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10024585 Country-Specific Treatment of Recovery Ratings Criteria (pub. 18 Jan 2019) https://www.fitchratings.com/site/re/10058988 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/10088587 Solicitation Status https://www.fitchratings.com/site/pr/10088587#solicitation Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. 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