Rolls-Royce's credit rating cut on profitability, cash-flow pressure

Rolls-Royce's long-term corporate credit and related debt have been lowered to 'A-/A-2', from 'A/A-1' by S&P Global Ratings, which cited profitability and cash-flow generation pressure in reaching its verdict.

Recent guidance from the aerospace and defence company indicated a weaker first half of 2016 that S&P Global said it expected, which increased the risk that these trends would persist for longer, and slow the pace and timing of recovery.

"The negative outlook reflects that we may lower the long-term rating within the next 12 months if we anticipate that Rolls-Royce's profits, cash flow, or leverage metrics will be weaker than we expect for 2016," it said.

S&P Global also lowered its long-term corporate credit and related debt ratings on aircraft-engine lessor Rolls-Royce & Partners Finance (RRPF) to 'BBB+' from 'A-', but affirmed its 'A-2' short-term corporate credit rating on that company, which is 50% owned by Rolls-Royce.

Returning to Rolls-Royce, S&P Global said its assessment was based on company guidance of a half-year pre-tax profit before interest of close to break-even, and cash flow significantly weighted to the second six months.

"We recognize that management guidance for the year as a whole is unchanged, and that in the aerospace and defence industry, the second half of the year is typically far stronger than the first half," the ratings outfit said, pointing to the company's greater reliance on the second half.

It had slightly lowered its forecast for profit margins and cash flow for 2016 and 2017, compared with its last-base case scenario, which assumed slightly lower revenues in 2016, followed by a slight increase in 2017.

It was also predicting reported pre-tax profit before interest of about £0.6bn in 2016, at a margin of about 5%. For 2017, it factored in a moderate increase in pre-tax profit before interest, supported by higher volumes and better business mix, as well as benefits from cost efficiencies.

S&P Global put annual capital expenditure at about £1.2 billion, up on 2015 but consistent with Rolls-Royce's guidance, and foresaw lower dividend cash payments in 2016 of about £300m. It also assumed neither further share buybacks nor material acquisitions or disposals.