S&P downgrades Rolls-Royce's credit outlook on demand concerns

Standard & Poor's has cut Rolls-Royce's debt outlook to 'negative' due to what it sees as weaker business prospects at the engine-maker.

The credit agency revised the credit outlook from 'stable' and confirmed its 'A/A-1' long- and short-term corporate credit ratings on the company.

S&P also affirmed its ratings on the FTSE 100 defence and aerospace group's other debt but revised to 'negative' from 'stable' the outlook on Rolls-Royce's 50%-owned finance arm.

The negative outlook means the credit agency is poised to lower the ratings on Rolls-Royce by one notch within the next year.

"This is because the company faces a number of near-term challenges that are pressuring group profitability, cash flow generation, and leverage metrics in 2016. We forecast these measures to come in below 2014 and 2015 levels and 'underperform' our previous expectations."

With its civil aerospace margins being squeezed by the transition to less-profitable engine models and lower demand for business jets and the marine business suffers from a reduction in demand, Rolls-Royce's previously considerable headroom in its leverage is likely to reduce "significantly" in 2016.

While the ratio of funds from operations (FFO) to £1.7bn adjusted debt as of 30 June was calculated at above 100% in the 2015 financial year, for 2016 S&P sees a increasing prospect of a "quite weak" ratio of around 60%.

"Should we expect such metrics to remain quite weak into 2017, we may lower the ratings. In addition, we may lower the ratings if we conclude that Rolls-Royce's profitability is sustainably impaired--for example, if there are further reductions in profit guidance for 2016 and limited prospects of improved margins for 2017."

S&P acknowledged that Rolls' management has begun to take steps to improve things, curtailing the buy-back programme, issueing new debt and indicating they would review the level of the 2015 final dividend payment, but the agency said weaking margins and cash flow, among other factors, would be likely to lead to downgrades.