) and its subsidiary Boeing Capital. The ratings are removed from CreditWatch, where they were placed on Mar. 18, 2003. The 'A-1' short-term corporate credit and commercial paper ratings on Boeing and Boeing Capital were previously affirmed and were not on CreditWatch. The outlook is stable. Combined rated debt for both entities is about $14 billion.
The downgrade reflects weak commercial aerospace intermediate-term business prospects and Boeing's increased and sizable unfunded pension and retiree medical liabilities, partly offset by growing contributions from the company's defense operations.
The continued sluggish global economy, the lingering effects of the Iraq war, and, more recently, the impact from the severe acute respiratory syndrome (SARS) outbreak further worsened already weak demand for air travel. The resulting massive losses and poor liquidity of airline customers, especially in the U.S., combined with excess capacity, create considerable uncertainty as to the timing and strength of an eventual market recovery. Still, long-term business fundamentals seem favorable, supported by expected economic growth and the need to replace older planes.
The reduced demand for jetliners coincides with significantly reduced profitability of Boeing Capital, Boeing's captive finance company. This stems primarily from poor financial performance of many airlines, restructurings of several bankrupt air carriers, a substantial decline in the value of aircraft collateral, and depressed lease rates. However, capital infusions from the parent helped Boeing Capital to maintain appropriate capital structure for the type of assets financed.
In contrast to the severe downturn in commercial aerospace, the U.S. defense budget has been rising and is expected to grow at a moderate rate for the next several years. Boeing is one of the largest defense companies, with diversified operations and a number of major, well-positioned programs and good profitability. Defense-related revenues for 2003 are expected to contribute a little over 50% of total revenues, with further gains anticipated for 2004. Accordingly, despite lower demand for commercial aircraft, the company's overall financial performance is expected to remain solid.
Boeing's credit protection measures, not including a $7.1 billion shortfall in the company's pension plans funding and $8.3 billion in unfunded retiree medical obligations (at Dec. 31, 2002), are strong for the rating, with funds from operations to debt expected to be about 75% in 2003. This ratio includes operating leases, but excludes Boeing Capital debt, about $600 million of nonrecourse customer financing debt, and any benefit from excess cash balances (cash and equivalents were $2 billion at Mar. 31, 2003). A gradual improvement in the credit profile is anticipated over the next few years.
However, when adjusted for the underfunded postretirement liabilities, book equity is largely eliminated, employing Standard & Poor's current methodology, with a significant adverse impact on other credit measures. Moreover, pension funding could be a long-term issue and a material use of cash in future years. Still, Standard & Poor's expects that Boeing's cash flow will remain strong and sufficient to cover operating needs, sizable R&D outlays, pension contributions (discretionary in 2003 and about $1 billion required in 2004), payments for benefits other than pensions ($440 million in 2002), dividends (about $575 million), and customer financing requirements. Free cash flow is expected to be $2.0 billion-$2.5 billion in 2003 and over $2.5 billion in 2004, net of pension contributions. Ample liquidity is enhanced by $4.5 billion of unused credit capacity and relatively light debt maturities.
Ratings on Chicago, Ill.-based Boeing are supported by its position as one of two global producers of commercial aircraft, generally favorable long-term fundamentals for that business, very strong position in defense and military space with moderately attractive growth prospects, efficient operations, and anticipated good overall financial performance.
Boeing and Boeing Capital are viewed by Standard & Poor's as a single economic entity. Therefore, the corporate credit rating for Boeing Capital is the same as that for Boeing. Under a revised strategy announced in late 1999, Boeing Capital's focus is to support the sale of Boeing's products and services, primarily in the commercial aircraft market. That activity accounts for 75%-80% of the finance unit's portfolio, with the balance composed of executive aircraft and industrial equipment, such as machine tools and production equipment.
Outlook: The outlook is stable. The very challenging operating environment in commercial aerospace and concern about the sizable underfunded postretirement liabilities should be mitigated to a significant degree by improved growth prospects for Boeing's defense operations, substantial cash generation, and good liquidity. Therefore, Boeing's credit quality should be maintained at the current level. From Standard & Poor's RatingsDirect