S&P Global Ratings

oThe spread of the COVID-19 pandemic continues to severely disrupt global air travel, with most airlines grounding most or all of their fleets.

oWe expect that many airlines will try to delay taking delivery of new planes until at least the end of the summer 2020, or cancel orders where they can, which will likely result in Airbus and Boeing postponing deliveries and lowering production rates.

oWe therefore consider that Rolls-Royce's civil aerospace division will likely be affected by lower engine sales and lower fly-by-the-hour receipts from airlines in 2020.

oWe are therefore placing our ratings on Rolls-Royce on CreditWatch with negative implications.

oWe plan to resolve the CreditWatch as soon as we can further assess and quantify the impact of COVID-19 on Rolls-Royce PLC's financial performance and liquidity position.

LONDON (S&P Global Ratings) March 27, 2020-- S&P Global Ratings today took the rating actions listed above.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Rolls-Royce's civil aerospace division generates revenues and cash flows in two primary ways. First, from the sale of new engines for large passenger aircraft, predominantly for wide body airplanes built by Airbus, but also Boeing. Second, Rolls-Royce's installed engine base creates significant aftermarket engine servicing, maintenance, repair, and spare-parts business, based on the number of flying hours and the frequency of maintenance and repair shop visits. Under normal circumstances, these generate long-term revenue with good visibility. As the installed engine base increases over the next few years, Rolls-Royce anticipated that the number of flying hours and maintenance shop visits should also grow, supporting improvements in aftermarket profits.

However, as governments attempt to halt the spread of the COVID-19 pandemic, with most global and regional air travel shut down, we note that the majority of airlines have grounded most or all of their fleets. We currently expect a likely fall of about 30% in airline flying hours in 2019 (see "Ratings On European Airlines Lowered And Placed On CreditWatch Negative Due To Coronavirus Outbreak," published March 20, 2020). We expect many airlines to push hard to delay taking delivery of new planes until at least the end of the summer 2020, which in turn will affect delivery and therefore production rates at Airbus and Boeing. We believe that this will, in turn, constrain Rolls-Royce's engine sales volumes for 2020 and 2021. In addition, we think that the wholesale grounding of fleets by airlines globally will materially affect the expected financial performance of Rolls-Royce's aftermarket business.

Prior to the spread of the COVID-19 pandemic and its sudden and severe impact on the global airline industry, our expectations for 2020 were that Rolls-Royce would exhibit overall top-line growth in the low-to-mid single-digits in 2020 and 2021 (see "Rolls-Royce PLC 'BBB-' Ratings Affirmed; Outlook Revised To Stable On Forecast Improvement In Financial Performance," published Jan. 28, 2020). We previously expected reported operating profits to continue to rise, trending to more than £1 billion in 2021. This included ITP Aero, an aero-engine component designer and manufacturer. We expected that Rolls-Royce would, through 2020 and 2021, gradually raise adjusted margins back to about 11%-13%, with adjusted debt to EBITDA of between 1.4x and 1.6x, and FFO to debt of more than 45%. We expected FOCF to remain very weak in 2020 and significantly positive in 2021.

We previously indicated that we would lower the ratings if we thought that the chances of a recovery in Rolls-Royce's profitability, cash flows, or credit metrics had slowed to below our expectations for 2020. Specifically, if adjusted EBITDA margins were below 11%, FFO to debt were to remain sustainably below 45%, and if the company achieved at least breakeven free operating cash flow (FOCF) in 2020 and significantly positive FOCF in 2021. We now believe that there is a material risk that Rolls-Royce's profitability, cash flows, and credit metrics could be below our expectations for 2020.

We plan to resolve the CreditWatch as soon as we can further assess and quantify the impact of COVID-19 on Rolls Royce PLC's financial performance and liquidity position.

Related Criteria

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oCriteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019

oCriteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018

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oCriteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014

oCriteria | Corporates | Industrials: Key Credit Factors For The Aerospace And Defense Industry, March 25, 2014

oCriteria | Corporates | General: Corporate Methodology, Nov. 19, 2013

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oGeneral Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012

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Related Research

oAirbus 'A+/A-1+' Ratings Put On Watch Negative On Aircraft Delivery Delays Linked To COVID-19, March 27, 2020

oBoeing Co. Announces A Two-Week Shutdown Of Its Seattle-Area Operations, Ratings Remain On CreditWatch Negative, March 23, 2020

oRatings On European Airlines Lowered And Placed On CreditWatch Negative Due To Coronavirus Outbreak, March 20, 2020

oRolls-Royce PLC 'BBB-' Ratings Affirmed; Outlook Revised To Stable On Forecast Improvement In Financial Performance, Jan. 28, 2020

oIndustry Top Trends 2020: Aerospace And Defense, Nov. 18, 2019

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S&P Global Ratings is a division of S&P Global (NYSE: SPGI), which provides essential intelligence for individuals, companies and governments to make decisions with confidence. For more information, visit www.spglobal.com/ratings.

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