The latest Investing Matters Podcast episode featuring Jeremy Skillington, CEO of Poolbeg Pharma has just been released. Listen here.
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2nd part
The outlook for the recovery of global air passenger volumes has deteriorated in recent weeks as European countries have reintroduced quarantine measures and travel restrictions remain in place globally particularly on long haul routes that are critical to Rolls-Royce's engine fleet. This is expected to drive a weak recovery in the fourth quarter of 2020 and during 2021, and may put further pressure on demand and production rates for large commercial aircraft. As a result Moody's expects the sector recovery to be at the lower end of its expectations. This is partially mitigated by the company's relatively young aircraft engine fleet and broad geographic mix of markets served. Rolls-Royce assumes in its "severe but plausible downside scenario" outlined its half-year results, that engine flight hours will reduce by 64% in 2020 compared to 2019 and recover by 28% in 2021, i.e. remaining 55% below 2019 levels. Given the current outlook there is a high probability that flight hours are in line with or worse than this scenario.
At its half year results the company's auditors emphasized going concern issues in the event that the severe but plausible downside scenario occurs, which would require additional funding in order to maintain sufficient liquidity. This would include the replacement of the company's GBP1.9 billion revolving credit facility maturing in October 2021, and further funding over and above. Cash outflows in a weaker recovery scenario would be driven by engine shop visit costs, which Moody's does not expect to reduce in line with flight hours, and potential costs of over-hedging of foreign exchange.
The company has stated that it is evaluating potential fund raising including up to a GBP2.5 billion equity rights issue, and additional debt issuance. Whilst this would be credit positive Moody's expects these transactions primarily to address liquidity concerns rather than materially repair the balance sheet. There remain risks that additional financing would still be required depending on amounts raised and the evolution of trading, which if not addressed could lead to further pressure on ratings.
The company has also reported its intentions to dispose of certain trading assets, including ITP Aero, with target proceeds in excess of GBP2 billion. Moody's does not include any disposals in its credit assessment at this stage in view of uncertainties over execution.
In August Rolls-Royce reported that blade deterioration in the intermediate pressure turbine had been detected on around 20% of its XWB-84 engines of 4-5 years' service. The company is replacing the blades as a precaution at existing shop visits and does not expect material additional costs. The XWB has been a successful programme with strong performance to date. Rolls-Royce does not yet know the cause of the problem and therefore cannot give absolute certainty over fix costs, although the costs of the interim solution should be relatively predictable.
Rating Action: Moody's downgrades Rolls-Royce to Ba3 from Ba2; outlook remains negative
25 Sep 2020
London, 25 September 2020 -- Moody's Investors Service ("Moody's") has today downgraded the corporate family rating (CFR) of Rolls-Royce plc (Rolls-Royce or the company) to Ba3 from Ba2. Concurrently Moody's has downgraded the company's long-term senior unsecured rating to Ba3 from Ba2. The outlook remains negative.
Today's rating action reflects:
• A worsening outlook for recovery of flight hours and deliveries in the company's large commercial engine division over the remainder of 2020 and in 2021
• Expectations for cash outflows in 2020 and 2021 at the higher end of Moody's estimates, which could put pressure on liquidity and balance sheet metrics in the absence of further finance raising
• Whilst the company is evaluating potential equity and debt issuance, which would be credit positive, concerns that this would not be sufficient to maintain a balance sheet commensurate with a Ba2 rating
Moody's has also downgraded the rating on the company's senior unsecured Euro Medium Term Notes (EMTN) programme to (P)Ba3 from (P)Ba2, downgraded the notes issued under the EMTN programme to Ba3 from Ba2, and downgraded the company's probability of default rating to Ba3-PD from Ba2-PD.
RATINGS RATIONALE
The company's Ba3 corporate family rating reflects: 1) high barriers to entry given the critical technological content of the company's engines; 2) the solid performance of the company's defence division and its diverse revenues across different end markets; 3) the strong to date performance of the company's Trent XWB and Trent 7000 engine programmes which represent the majority of future orders and installed engine base; 4) the strategic importance of the company to UK defence capabilities and to the aerospace supply chain, resulting in a high likelihood of government support if required as a result of the coronavirus outbreak; and 5) the company's commitment to a conservative financial profile.
The rating also reflects: 1) a weakening environment for commercial aerospace in view of a slow recovery of engine flight hours pressured by travel restrictions, quarantine measures and broader coronavirus outbreaks across several regions; 2) Moody's expectations for substantial free cash outflows in 2020 and 2021 and possibly beyond, leading to increases in leverage which the company faces challenges to recover over the next 2-3 years; 3) high uncertainties over the progression of the coronavirus pandemic which could lead to further material cash outflows; 4) execution risks in implementing a material restructuring programme whilst maintaining operational effectiveness and competitive position; 5) ongoing execution risks in concluding fixes relating to the Trent 1000 engine programme; and 6) a degree of concentration risk with reliance on a small number of commercial aerospace engines for widebody aircraft.