April 4, 2017 / 4:52 PM / 4 months ago

Fitch Affirms CSRA's IDR at 'BBB-'; Outlook Revised to Negative

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(The following statement was released by the rating agency) NEW YORK, April 04 (Fitch) Fitch Ratings has affirmed the Issuer Default Rating (IDR) assigned to CSRA Inc. (NYSE: CSRA) at 'BBB-'. The Rating Outlook has been revised to Negative. Approximately $3.1 billion of debt outstanding as of Dec. 30, 2016 (including the company's outstanding accounts receivable facility) is affected by this action. The Negative Outlook reflects that revenue has underperformed management guidance provided prior to the spin & merger transactions as well as over the course of operation as an independent entity. In addition, the company has not reduced total leverage as much as Fitch expected, as a result of adverse top-line performance. Fitch has affirmed the company's IDR despite top-line performance challenges, because the company has maintained peer-leading margins and expects the strong FCF generation (in excess of $300 million) to provide meaningful capacity to reduce leverage going forward. Competitive pressures and potential key contract delays and/or losses will mean the company may not halt its recent revenue decline or be able to maintain its margins. Additionally, CSRA may face pressure to increase shareholder returns and possibly to pursue acquisitions, at the expense of debt reduction. Outright negative rating action will be appropriate should these scenarios play out. KEY RATING DRIVERS Revenue Inflexion Point on Horizon: Revenue declined 4.5% year-over-year in FY2016 on a pro forma basis and is on track to decline 4% in FY2017. Revenue declines have averaged 4.5% y/y over the company's five quarters as an independent, combined entity. Revenue declined 3.6% in the most recent quarter (3Q17) although signs point to a potential turning point as sequential declines have decelerated and even turned positive (+1.7%) in 3Q. Fitch sees recent momentum as encouraging and expects the CSRA's efforts to scale its business development platform will lead to positive top-line growth beginning in FY2018. Limited Visibility: Given uncertainties surrounding key contracts and increased competitive pressures, while Fitch sees the company returning to growth in the next fiscal year, we do not expect CSRA to post annual growth rates approaching the lower end of long-term guidance until FY2020. The company has yet to provide FY2018 guidance but has stated it continues to see an opportunity to produce growth in line with the "long-term model" of 2%-3% annually. Y/Y revenue declines do not compare favorably with management's stated target of 2%-3% annual revenue growth dating back to the formation of CSRA in 2015. On two occasions management has either missed the midpoint of its guidance (-1.1% 4Q16) or revised full-year guidance lower (-2.4% FY2017) nearly half-way into the respective fourth quarter. Leading EBITDA Margins Maintained. Despite top-line challenges, the company has maintained EBITDA margins in excess of 17% and above its long term model of 16% to 17%. This compares favorably with other government IT contractors which typically have margins less than 10%. Management has achieved this by weighting its contract mix towards more profitable fixed-price (46% in Q3 FY2017) vehicles, realizing synergies associated with the integration of SRA, and continuing to execute on its strategy to develop lower-cost delivery methods. Going forward, Fitch expects the company to post EBITDA margins in line with its long term model, albeit somewhat below recent results due to competitive pressures. FCF Generation Yields Leverage Reduction Potential. The company is on track to generate around $300 million in free cash flow in fiscal 2017 (6.0% FCF margin) owing to improved working capital management, a favorable amendment to its term loans, and a lower capital expenditure profile. Fitch expects FCF to increase 6% CAGR through FY2020 driven by a decline in interest expense and a reduction in capital intensity, predicated on top-line growth and maintaining EBITDA margins in line with guidance. During the year the company paid down the $50 million balance on its revolving credit facility, paid $48 million in excess cash flow on its term loan facilities, and made a $30 million voluntary repayment in addition to $81 million in mandatory principal repayments. Potential Shareholder Capital Return Pressures. The company has returned and authorized approximately $67 million in dividends in FY2017 and conducted nearly $30 million in share repurchases (reported through 3Q17). Since the spin & merger the company has achieved shareholder capital returns of around 35%, below its financial policy target of returning 40% of FCF to shareholders. The company had authorization to repurchase $321 million of stock by the end of FY2018. Fitch expects the company to face pressure to increase its dividend in line with other S&P 500 index constituents and sees potential for it to ramp up share repurchases in the future. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for CSRA Inc. include: --4Q17 results leading to FY2017 full-year revenue at the midpoint of downwardly revised management guidance of $4.96 billion - $5.01 billion (from $5 billion - $5.20 billion). --Positive organic revenue growth beginning in FY2018, half of lower-end of 2%-3% long-term management model, rising to 1.5% in FY2019 and 2% in FY2020, reflecting increased competition and uncertainty surrounding key contracts. --Approximately 17.5% aggregate FY2017 EBITDA margin reflecting recent performance, settling to 16.5% in FY2018 in line with midpoint of management model as a weighting towards fixed-price contracts, realized synergies, and lower cost delivery methods prevail but are offset to some degree by increased competition and pricing pressures as a result of government procurement practices. --Dividends paid in FY2017 of approximately $67 million, and held constant throughout the forecast period. Share repurchases of approximately $30 million annually through FY2019, assuming extension of the share repurchase program set to expire at the end of FY2018. --Excess cash flow payments of $72 million in 1Q18 and $36 million in 1Q19 but no subsequent payments as total secured consolidated debt to consolidated EBITDA falls below 2.5x. Voluntary repayments of $125 million in FY2018 and FY2019 to Term Loan A. RATING SENSITIVITIES While Fitch does not anticipate positive rating action over the forecast horizon, positive rating actions could be considered if operating performance were to improve dramatically with top-line revenue growth exceeding 3% such that Fitch expects management to reduce debt more aggressively than expected, bringing leverage to 2.5x or below. Negative rating actions would likely occur if either: --Key contract losses or increased competitive pressures result in expected adverse operating performance characterized by further negative revenue growth or EBITDA margins below 16.0%; --Adverse operating performance, increased shareholder capital returns or acquisitions diminish debt reduction such that total debt to EBITDA is not expected to decline below 3.0x, or voluntary prepayment of debt is expected to be on the order of less than $125 million annually. Fitch expects that any potential negative rating action would be limited to one notch. LIQUIDITY Fitch views CSRA's liquidity as adequate and supported by expected FCF generation. Additional financial flexibility is provided by the company's $700 million revolving credit facility (fully available as of Dec. 30, 2016) and $138.8 million of unrestricted cash on hand as of Dec. 30, 2016. FULL LIST OF RATING ACTIONS CSRA Inc. --Long-Term Issuer Default Rating (IDR) 'BBB-'; --Senior secured revolving credit facility 'BBB'; --Senior secured term A loans 'BBB'; --Senior secured term B loan 'BBB'; The Rating Outlook is revised to Negative from Stable. List of any disclosures relevant to the rating action(s): --Fitch criteria for rating non-financial corporate entities consider accounts receivable factoring facilities to be debt. Previous ratings did not properly account for the company's $450 million facility and improperly treated it as available liquidity. To correct this, Fitch has added the company's $450 million accounts receivable facility to total debt and appropriately considered the inclusion in calculation of total leverage. Contact: Primary Analyst Kevin McNeil Director +1-646-582-4768 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst David Peterson Senior Director +1-312-368-3177 Committee Chairperson Dino Kritikos Senior Director +1-312-368-3150 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Date of Relevant Rating Committee: April 3, 2017 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Fitch added to total debt $450 million of outstanding accounts receivables sold under the company's Master Accounts Receivable Purchase Agreement. --Fitch reduced cash available as of Dec. 30, 2016 by $23.3 million reflecting cash collected but not remitted due to timing of collections and settlements associated with the company's Master Accounts Receivable Purchase Agreement. 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