Moody’s upgrades Rolls-Royce rating, maintains positive outlook

Investing.com -- Moody’s Ratings has upgraded the long-term issuer ratings of Rolls-Royce (OTC:RYCEY) plc, a manufacturer of aero-engines, propulsion and power systems, from Baa3 to Baa2. The ratings agency also upgraded the company’s backed senior unsecured Euro Medium Term Notes (EMTN) program rating from (P)Baa3 to (P)Baa2. The outlook for the company remains positive.

The upgrade is a reflection of Rolls-Royce’s continued strong operating and financial performance, driven largely by the successful execution of its transformation program and a supportive market environment. Frederic Duranson, a Moody’s Ratings Vice President – Senior Analyst, noted that these factors are expected to continue improving the company’s profitability, cash flows and financial leverage. The company’s conservative financial policy, which led to a net cash position at the end of December 2024, also contributed to the upgrade.

Rolls-Royce’s credit quality has been improving due to sustained increases in profitability and cash flow. The company’s Civil Aerospace division is the primary driver of its credit profile. Key factors behind the company’s strong performance include large commercial engine flying hours above 2019 levels and a transformation program that has resulted in better pricing and cost savings.

In 2024, Rolls-Royce’s operating profit rose to GBP2.5 billion from GBP1.6 billion in 2023, and free cash flow increased to GBP2.4 billion from GBP1.3 billion. This strong performance has brought the company closer to achieving its medium-term targets of GBP2.5 billion – GBP2.8 billion operating profit and GBP2.8 billion – GBP3.1 billion free cash flow, which were set as recently as 2023. Consequently, the company has raised its targets and aims to reach them by 2028.

Rolls-Royce is committed to maintaining the strength of its balance sheet and used existing cash to repay debt in 2024, with plans to do the same in 2025. The company had no net debt at the end of 2024 and Moody’s-adjusted gross debt/EBITDA was 2.1x.

The company’s Baa2 ratings also reflect the high barriers to entry in the industry due to the critical technological content of the company’s engines, expectations for solid growth in commercial aerospace, good prospects in Defence and Power Systems, the strong performance of the company’s Trent (NSE:TREN) XWB and Trent 7000 engines, and the strategic importance of Rolls-Royce to UK defence capabilities and to the aerospace supply chain.

However, the ratings also take into account supply chain challenges and persistent inflation, which could limit profit improvements, some concentration risk due to the company’s relatively small number of commercial aerospace engines for widebody aircraft, and uncertainty over the company’s ability to achieve longer-term objectives.

Rolls-Royce’s liquidity is excellent, with total liquidity amounting to GBP7.8 billion as of 31 December 2024, including unrestricted cash of GBP5.3 billion and a GBP2.5 billion undrawn revolving credit facility maturing in November 2027. The company has publicly committed to repaying its $1 billion notes maturing in October 2025 from existing cash.

The positive outlook reflects expectations that Rolls-Royce will continue to improve its credit metrics and strengthen its track record in the next 12 to 18 months. The outlook also assumes that the company will maintain a conservative financial policy prioritising balance sheet strength and substantial liquidity.

The ratings could be upgraded if Rolls-Royce continues to perform at or above guidance, maintains a conservative financial policy allowing Moody’s-adjusted gross debt/EBITDA to stay well below 2.5, continues to generate substantial Moody’s-adjusted free cash flow, and maintains liquidity in the range of GBP5 billion to GBP7 billion. However, the ratings could be downgraded if improvements in operating profit and margin achieved until 2024 reverse, or if the company’s business profile deteriorates.

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