Rolls-Royce downgraded to triple B minus - one notch above junk

Rolls-Royce's ambition to return to having a blue-chip single-A credit rating has taken a hit following Standard & Poor's (S&P) decision to downgrade the aero-engine manufacturer to just one notch above junk - the company's second reduction in three months.

S&P announced that it would cut the UK engineering company's long-term rating following a profit warning two weeks ago. The outlook, at least for the short-term, was negative as a result of continued uncertainty around Brexit with the risk of further turmoil following the general election in two weeks.

“We regard Rolls-Royce’s profitability as weak and volatile, and below average compared with peers in the aerospace and defence industry,” S&P said.

The downgrade - to triple B minus, from the triple B it was issued in August - come after similar reductions from fellow credit agencies Moody's and Fitch. A further downgrade to junk status could have devastating consequences for Rolls-Royce. Many large investors would be compelled to sell as they are restricted to holding shares in companies with investment-grade status.

The downgrades came after the group’s recent warning that the costs of resolving problems with its Trent 1000 engine family would be higher and last longer than expected. It said cash costs of the crisis would come to £2.4-billion (€2.82-billion) between 2017 and 2023, against the previous forecast of £1.6-billion (€1.88-billion). In addition, it warned profits would be hit by a £1.4-billion (€1.64-billion) exceptional charge this year.

S&P said that the warning was a signal of “weaker recovery of profitability, free operating cash flows (FOCFs), and credit metrics, compared with our previous expectations”.

Rolls-Royce CEO Warren East, who was appointed in 2015 has repeatedly asserted that his ambition is to return the company back to single-A grade credit status, which it last held in 2017. Nonetheless, the issues with the Trent engine have absorbed the benefits that were starting to show after several years of restructuring.

It could take the best part of a decade to get back to the single-A grade status according to some analysts. 

“You have got to get through the remaining two years plus of Trent 1000 costs. Then you have to come out the other side of a slowdown in widebody aircraft,” Nick Cunningham of Agency Partners told the FT.

“At that point there will be other variables such as how much you are spending on research and development, electrification, etc.”

Rolls-Royce has insisted that the downgrade will not have any material impact on its business. “We have plenty of liquidity and limited debt maturing over the next few years and do not expect an impact to our hedge book or any other financing activities,” the company said.

A company spokesperson said: “Our cash flows will improve meaningfully as we look ahead to 2020 and the midterm, which will be a key driver of us achieving the improvement back to a strong single-A credit rating over time.”

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