RE: RR MOODY's27 Sep 2020 21:41
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.
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