Approval of German Arms Export Licences Is Credit Positive for Heckler & Koch
Last Thursday, the German government approved a number of arms export licences to Middle Eastern and
other countries that are not members of the North Atlantic Treaty Organization (NATO). The licence
approvals included licences for Heckler & Koch GmbH (Caa3 negative), which is credit positive because
they will support the company’s free cash flow. Improved cash flow is essential if the company is to make its
€14 million semi-annual interest payments in 2015.
Based on the number of weapons cited in the government’s list of licence approvals, we expect the cash
effect to be a portion of the €50 million (which equals around 23% of 2013 revenues) worth of Heckler &
Koch’s export requests as of June. Nevertheless, it will increase 2014 earnings and most importantly the
company’s cash flow in 2014 and early 2015. We previously assumed no contributions from sales requiring
export licences in 2014.
However, we do not expect these approvals to improve the company’s low unrestricted cash balance, which
totalled €8.3 million at 30 June 2014, before a €14 million interest payment the company has due on 15
November. The company’s low cash balance and scheduled interest payments were a key factor behind our
September downgrade of Heckler & Koch to Caa3 negative from Caa2 negative. Licence approvals will
now allow an unwinding of inventories (a large proportion of contracts requiring licence approvals had been
partly finished), but cash contributions will only be realised toward and beyond year-end given the time
between receipt of government licences, final delivery of weapons and receipt of cash payment.
Moreover, although approvals granted across the industry to supply non-NATO members and countries
with questionable human rights records is credit positive for German defence companies overall, for
Heckler & Koch, export requests remain. In addition to the remaining portion of the €50 million in export
requests not yet approved, the company also has identified program awards for a further €50 million in
2015 to customers for whom the export licensing policy is still not clear. Delays in the approval of the
remaining export requests will prevent further improvement in Heckler & Koch’s cash balances. Improved
cash balances would increase the company’s ability to sustain further unexpected earnings fluctuations (in
the first half of 2014, turnover declines drove a 60% drop in EBITDA from a year earlier) and
unpredictable working capital movements stemming from the nature of Heckler & Koch’s operations.
The timing and amount of approvals for additional export requests is uncertain given that Germany’s
foreign policy appears to be in a state of flux. A more cautious stance toward arms sales was previously
championed by German Economy Minister Sigmar Gabriel, who in the wake of recent crises finally allowed
the approval of recent export licences. In addition, German Foreign Minister Frank-Walter Steinmeier
supported military assistance to the Iraqi government in late August, and in late September, announced in
front of the United Nations General Assembly that Germany intended to increase its international military
role. This may support some convergence of opinion with other top German politicians who appear to be
paving the way for a more active foreign policy that is more consistent with Germany’s Western allies.
However, we believe events in the Middle East and the ability for rifles and pistols to more easily appear in
unauthorized states and in enemy hands, versus the delivery of armoured vehicles, for example, may
encourage the government to maintain a more vigilant approach toward the approvals of Heckler & Koch’s
licences. Whether an escalation of events in the Middle East, and the need for a greater military assistance
increases demand for Heckler & Koch’s weapons in the region, remains to be seen.
