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Rating Action:

Moody's downgrades Rolls-Royce to Baa2 from Baa1; outlook stable

20 Nov 2019

London, 20 November 2019 -- Moody's Investors Service ("Moody's") has today downgraded the long-term senior unsecured rating of Rolls-Royce plc (Rolls-Royce or the company) to Baa2 from Baa1. The outlook is stable. Today's rating action reflects:

• Further increases in Trent 1000 related costs to GBP2.4 billion and delays until 2021 in rectifying problems relating to the Trent 1000 TEN engine

• Potential for material reputational risks as a result of continued customer disruption

• Risks associated with execution of Trent 1000 fix and future growth in cash flows

• High Moody's-adjusted leverage and low free cash flow generation

Concurrently, Moody's has downgraded the rating on the company's senior unsecured Euro Medium Term Notes (EMTN) programme to (P)Baa2 from (P)Baa1, and downgraded the notes issued under the EMTN programme to Baa2 from Baa1.

RATINGS RATIONALE

The company's Baa2 senior unsecured rating reflects: 1) the company's strong business profile supported by an order backlog of more than 4x 2018 underlying revenue; (2) high barriers to entry given the critical technological content of the company's engines; (3) the positive outlook for aerospace and defense and for some niche segments in the company's power systems division; (4) the strong to date performance of the company's other new engine programmes which represent the majority of future orders and installed engine base (5) commitment to a conservative financial profile and (6) strong liquidity.

The rating also reflects: 1) high Moody's-adjusted leverage of 5.3x as at June 2019, which Moody's expects to remain above 4x at December 2019; 2) high and increasing costs of rectifying problems on the Trent 1000 engine programme, with ongoing execution risks; 3) limited free cash flow (FCF) generation, and expectations that future growth in FCF will be bolstered in the near term by unsustainable working capital gains; 4) concentration risks with reliance on a small number of commercial aerospace engines for widebody aircraft; 5) risks in delivering the company's transformation and cost saving plans; 6) risks in achieving growth in aftermarket profits, which depend on future engine maintenance costs.

On 7th November 2019 Rolls-Royce announced that as a result of issues with the TEN variant of its Trent 1000 engine, the company's specifically disclosed estimates for remediation costs associated with the Trent 1000 programme will increase to GBP2.4 billion from GBP1.6 billion. The company also announced that its remaining blade component redesign would not be completed before the first half of 2021, compared to early 2020 as previously reported, and that the redesigned blade will have lower durability than previously expected. The company will record a provision of circa GBP1.4 billion in its 2019 accounts for the additional GBP800 million remediation costs and a further GBP600 million for losses on Trent 1000 long term maintenance contracts as a result of expected lower component durability for the TEN engine variant. The company also reported that it was investing in further resources to resolve the issue and reduce aircraft on ground, also increasing its stock of spare engines by around GBP200 million.

Moody's considers that the company's guidance for Trent 1000 remediation contains a greater degree of caution than in the past, but that execution risks remain. These could lead to loss of market share on the Boeing 787, further remediation delays or costs, lower aftermarket profitability, and longer-term damage to the company's reputation. Moody's has taken the decision to downgrade the ratings as a result of these ongoing risks, higher cash costs of remediation, and continued challenges in improving currently weak leverage and cash flow metrics. At the same time Moody's notes the solid performance of the Trent XWB and Trent 7000 engines which will represent the majority of the future engine fleet.

Governance considerations that Moody's includes in its credit assessment of Rolls-Royce includes: (1) the company is listed on the London Stock Exchange and was fully compliant with the UK 2016 Corporate Governance Code. The company has reviewed the new Code issued in 2018 and taken steps to address governance issues identified from that review; and (2) Rolls-Royce's complex business model and financial reporting is a significant challenge in understanding financial performance, particularly in relation to profitability on long-term aftermarket contracts, quality of cash flows, and adjustments to normalised profits.

LIQUIDITY

Rolls-Royce continues to maintain strong levels of liquidity. As at 30 June 2019 the company's total liquidity amounted to GBP6.7 billion, comprising cash on balance sheet of GBP4.2 billion and GBP2.5 billion undrawn bank facilities available until 2024. Short term borrowings and lease liabilities as at 30 June 2019 amounted to GBP464 million which Moody's expects to be met from balance sheet cash. Whilst cash balances are bolstered by receipts in advance from customers, notably on aftermarket contracts, Moody's expect levels of deferred revenues to increase in the next 12 -18 months and therefore will not absorb cash.

OUTLOOK

The stable outlook reflects Moody's expectations that the company will delever towards 4x (on a Moody's-adjusted basis) over the next 12-18 months. It also assumes that the company continues to grow free cash flow on a sustainable basis, (excluding working capital gains, but including movements in long term service agreement deferred revenue). The outlook assumes that the Trent 1000 engine issues are resolved within the framework guided by the company, without any additional disruption that would materially affect future cash flows, market shares or reputation. It is also assumed that aftermarket margins are sustained when recent engine programmes commence their first shop visits. Furthermore the outlook assumes that the company maintains a conservative financial policy and strong liquidity.

WHAT WOULD CHANGE THE RATINGS UP / DOWN

The rating could be upgraded if:

• The company achieves solid revenue growth accompanied by improved profitability, including operating profit margins increasing sustainably towards 10%

• Leverage reduces sustainably towards 3.0x on a Moody's-adjusted basis

• Moody's-adjusted FCF / debt increases sustainably above 5%

• Trent 1000 issues are resolved in line with guidance

• The company maintains strong liquidity and a conservative financial policy

The rating could be downgraded if:

• Moody's-adjusted debt / EBITDA fails to reduce sustainably towards 4.5x in the next 12-18 months, especially if not sufficiently balanced by cash on balance sheet

• Moody's-adjusted FCF / debt reduces sustainably towards zero

• There are signs of a weaker business profile, including a weakening in the company's market positions, or lower than expected aftermarket profitability, including as a result of further challenges in remediating Trent 1000 issues

• The company adopts more aggressive shareholder return initiatives and financial policies, or there is a substantial reduction in liquidity

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Aerospace and Defense Industry published in March 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

COMPANY PROFILE

Headquartered in London, England, Rolls-Royce is a leading global manufacturer of aero-engines, gas turbines and reciprocating engines with operations in three principal business segments -- Civil Aerospace, Defense and Power Systems. In 2018 the company reported revenue of GBP15.7 billion and Moody's-adjusted EBITDA of GBP1.3 billion.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

Martin Robert Hallmark
Senior Vice President
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Richard Etheridge
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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