TEXT-Fitch ups Rolls-Royce to 'A'; outlook stable
July 30 - Fitch Ratings has upgraded Rolls-Royce Holdings plc's (Rolls-Royce) Long-term Issuer Default Rating (IDR) and senior unsecured ratings to 'A' from 'A-' and Short-term IDR to 'F1' from 'F2'. The Outlook on the Long-term IDR is Stable.
"Over the past few years, Rolls-Royce has demonstrated an ability to successfully manage a broad portfolio of turbine related assets, and achieve a strong level of cash generation, regardless of industry challenges or wider global economic headwinds," says Tom Chruszcz, Director in Fitch's EMEA Industrials team. "The stability the company has shown in its earnings, coupled with a robust capital structure, confirm the strength of the business."
Financial results for H112 were slightly ahead of Fitch's expectations and showed that Rolls-Royce continued to grow its revenue base by 5%, driven by strong demand for its commercial aerospace products and services (which contribute more than half of group revenue), which grew by 17% in the period. Similarly, the underlying profit margin saw a slight lift to 12.1% from 11.8% as a result of a lift achieved by commercial aerospace. Underlying cash generation, as measured by funds from operations (FFO) also rose in the period to GBP665m, from GBP549m in H111, on the back of the increase in profitability. Fitch expects earnings margins and cash generation to remain relatively stable in the short to medium term.
Following the closing of the International Aero Engines (IAE) transaction, where Rolls-Royce exited the engine building consortium for a cash consideration of GBP950m, the group has regained its previously strong capital structure and financial flexibility, both of which remain robust for the current rating. At 30 June 2012, Rolls-Royce had a GBP187m lease-adjusted net debt position, an improved level from FYE11 (net debt of GBP830m), which had been affected by the H211 GBP1.3bn cash outlay related to the Tognum AG acquisition, but in line with levels achieved in prior years. The agency anticipates that Rolls-Royce's FFO gross adjusted leverage (which calculates at 1.7x at H112 on a last 12-month FFO basis) is likely to remain broadly stable over the coming two to three years at levels firmly within the 'A' range.
The 'A' rating reflect the company's strong market position as an aeronautic engine manufacturer in a concentrated market with high barriers to entry, its sizeable order backlog as well as the positive effect of the significant share of revenue that is derived from more predictable after-sales activities (53% in H112). The company's capital structure is strong, although Fitch notes that cash generation remains modest for the current rating.
The Stable Outlook reflects Fitch's expectation of stable profit margins and no material change in the company's capital structure in the medium term.
WHAT COULD TRIGGER A RATING ACTION?
Negative. A shift in financial policy, although considered unlikely by Fitch, could affect the ratings negatively. A more shareholder-friendly capital structure, either via an increased dividend or a share buyback, may have a rating impact. Lease-adjusted debt to FFO at more than 2x may put the ratings under pressure. Furthermore, a pre-financing FFO to revenue ratio of less than 10% on an ongoing basis, may put pressure on the ratings.
Positive: An upgrade is considered unlikely in the absence of a material change of the group's credit profile given that the company has reached a rating level near what Fitch considers to be the highest rating compatible with the aerospace and defence industry.
Rolls-Royce is a leading global gas turbine manufacturer, active in the civil (47% of LTM revenue) and defence (21%) aerospace markets, as well as the marine (22%) and energy (11%) segments. Consolidated LTM revenue at 30 June 2012 totalled GBP11.4bn, while the order book stood at GBP60bn.
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