Rolls-Royce has lost its investment-grade rating — held for the past 20 years — after Standard & Poor’s on Thursday downgraded the company to junk status because of “prolonged weak profitability” and expectations of materially lower cash flow from its engine service contracts.
The downgrade is a severe blow to the aero-engine company, which only last week announced plans to cut 9,000 jobs, mainly from its civil aerospace division.
Like many of its aerospace peers, it has had to adjust its cost base to a market which could be up to 50 per cent smaller in the next four years as a result of the coronavirus pandemic.
Many large investors will have to sell their debt holdings in the FTSE 100 company, as they are restricted to investing in investment-grade bonds. It could also hit profitability of future long-term service contracts, as the perceived risk for customers of striking multiyear deals would increase.
The downgrade comes as the aerospace and aviation industries are struggling to cope with the consequences of a virtual collapse in air travel. Airlines have been forced to appeal to governments for state bailouts to survive, and have in turn cancelled and deferred aircraft orders.
Rolls-Royce is doubly exposed, as it makes its profits on the number of hours its engines fly and is focused on the wide-body market where demand is expected to take significantly longer to return to 2019 levels.
Other rating agencies have in the past followed S&P’s lead on downgrades to Rolls-Royce’s credit rating. Fitch currently has Rolls-Royce on BBB+, two notches above junk, while Moody’s is at Baa3, one notch above non-investment grade.
S&P said that despite the crisis Rolls-Royce had established a “strong liquidity position”. It said “sources of liquidity will exceed uses by more than two times over the next 12 months”.
However, it expected Rolls-Royce’s civil aerospace division to be “materially affected by lower wide-body and business jet engine sales and lower engine flying hour-related receipts from airlines in 2020 and 2021”. Moreover, there was a risk that Rolls-Royce could post new one-off charges in the next 12 months.
The group, which was coming to the end of a two-year restructuring when the virus struck, said it regretted the loss of its investment-grade status, but it was confident that the cuts announced last week would be sufficient to meet expected medium-term demand.
The downgrade would not trigger any early debt repayments, it insisted, nor would it affect existing service contracts with airlines.
“We have taken swift action to increase our liquidity and dramatically reduce our spending in 2020 to deal with the short-term impact of Covid-19,” the company said in a statement. “These measures will assist us as we weather the pandemic and emerge from the other side into a global aviation industry which will take several years to return to the levels of activity seen in 2019.”
This article has been amended to clarify that many large investors will be required to sell their debt holdings, not equities.