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Rating Action:

Moody's Assigns A3 Ratings to New Rolls-Royce Notes

06 Oct 2015

Net Proceeds to (Mostly) Bolster Liquidity

New York, October 06, 2015 -- Moody's Investors Service assigned A3 ratings to the proposed new debt issuance by Rolls-Royce plc. Existing ratings for the company remain unchanged, including the A3 senior unsecured debt rating. The rating outlook remains stable.

RATINGS RATIONALE

"Rolls-Royce is capitalizing on historically low yields available in the US bond market to bolster its backstop liquidity provisions," said Russell Solomon, Senior Vice President and Moody's lead analyst for Rolls-Royce. "Although financial leverage will grow to an elevated range and consume much of the company's remaining embedded financial flexibility in the current rating category, we expect management will maintain its historically disciplined financial policies," Solomon added. "Net proceeds from the offering are expected to be mostly retained, with some leakage to fund the dividend payout over the interim period of ongoing heavy capital investment prior to a return to more robust free cash flow generation in the out years," according to Solomon.

Rolls-Royce has a large installed base encompassing about fifteen thousand engines for various civil aircraft programs, and is a strategic provider of propulsion systems for several key military platforms, as well. The company demonstrates fairly consistent strength in operating performance over the long and volatile aerospace cycle, aided by its sizeable backlog of orders (GBP76.5 billion, at list prices) for both original equipment and high-margin aftermarket services, which collectively enhance the relative stability and predictability of forward revenue streams. The company maintains strong liquidity and relatively disciplined financial policies. Solid long-term business prospects on civil aircraft programs (albeit now predominately in the widebody segment) suggest further stability of the credit profile over the extended rating horizon. Investments in new technologies, higher-margin services revenue streams and cost reduction initiatives will drive meaningful growth and ultimately boost margins and free cash flows in the next decade.

While we expect that increasing build rates of the large commercial airframers will drive incremental revenue and aftermarket service opportunities, cash flows will be constrained for several years given ongoing heavy investment and working capital absorption. Interim period pressure on profitability measures will be exacerbated by both mature programs that are slowing and/or transitioning to forthcoming new variants and young programs that are ramping up. The operating environment will be challenged further by lingering headwinds in government defense spending and pricing pressure in the company's land and sea segment, which has been increasingly susceptible to order deferrals, pricing renegotiations and rising cancellation activity. The marine business is expected to remain particularly exposed to our forecasted lower-for-longer oil price environment, with material spending cuts by end-customers showing no real sign of letting up. Rolls-Royce has implemented multiple cost-cutting initiatives and restructuring programs to improve performance and increase margins. These will take more time (and capital) to be realized but should enhance the company's competitive profile when the environment improves, and in conjunction with the enhanced liquidity will more favorably position its finances to accommodate the ongoing transitional period.

We anticipate that Rolls-Royce's financial leverage (Moody's-adjusted Debt-to-EBITDA) will approximate 2.5x proforma for the aforementiond debt issuance and reduced earnings forecast, up fairly materially from the mid-2015 level of 1.9x but with the explicit understanding that most of the net proceeds from the pending transaction will ultimately be retained in the form of excess cash balances. We anticipate gradual balance sheet strengthening by 2017 and a further acceleration of deleveraging thereafter as cost saving initiatives are more fully implemented, market conditions ultimately improve in certain segments that remain pressured (i.e.; marine, oil & gas), and earnings growth is realized. Even more central to the underlying credit thesis, though, is our expectation that profitability measures and free cash flows will improve appreciably as the heavy investment phase of the company's capital cycle transitions away from development and new model introductions over the next two-to-three years and more lucrative service-oriented revenue streams associated with Rolls-Royce's long-cycle civil aircraft business begin to grow again. We forecast the business will consume roughly GBP500-GBP600 million annually during the 2015-2016 period, after payment of the dividend on the company's common stock, before gradually recovering to a positive and then increasingly robust free cash flow generating profile by the end of the decade.

The stable rating outlook reflects the expectation of solid operating performance during the transitional period of shifting programs in both civil and defense and as pressures related to low oil prices and general macroeconomic volatility that are adversely impacting marine and power performance moderate over the balance of 2015 and 2016. Moreover, any increased exposures for customer financing and/or to the supply chain are expected to be manageable, with credit metrics remaining comfortably supportive of the A3 rating level. The stable outlook also incorporates our expectation that the company will maintain a strong liquidity profile and conservative financial policies.

Although not expected over the immediate rating horizon, upward rating momentum could occur if strong excess liquidity is expected to be maintained while financial leverage trends towards 1.5x, free cash flow coverage improves to around 40%, and solid interest coverage (EBIT-to-Interest above 10x) and profitability (margins of at least 10%) measures are evidenced.

Deterioration in credit metrics, particularly interest coverage (EBIT-to-Interest) below 5x and/or financial leverage that remains elevated in the absence of a meaningful liquidity buffer could pressure the ratings down. A sharp increase in customer financing calls and/or negative free cash flow over an extended period of time could also pressure ratings, as could a material erosion in liquidity or a shift to more aggressive shareholder return initiatives and financial policies, more broadly.

The principal methodology used in these ratings was Global Aerospace and Defense Industry, published in April 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Headquartered in London, England, Rolls-Royce is a leading global provider of gas turbines and reciprocating engines with operations in two broad business segments - Aerospace (civil and defense) and Land & Sea (marine, nuclear and power systems). The company reported revenue of GBP13.9 billion for the twelve month period ended June 2015.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Russell Solomon
Senior Vice President
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Robert Jankowitz
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Assigns A3 Ratings to New Rolls-Royce Notes
No Related Data.
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