08 August 2019 by jbchevrel
Rolls-Royce (ROLLS) H1-2019 results earlier this week (Aug 6) showed further progress with the recovery strategy. Core revenue rose +7%y, mainly thanks to Civil Aerospace (+11%y). EBIT rose +32%y. Negative FCF (-£0.4B) was expected, along with both seasonality and inventory builds for Civil Aerospace and Power Systems. The cash position improved, as expected, thanks to the disposal proceeds from the Commercial Marine unit (c£0.5B). On the negative side of the equation, challenges around Trent 1000 in service issues (co anticipates addl £0.1B more costs in 3y), restructuring efforts, and costs with the A380 weigh but seem +/- under control. More importantly, the Brexit risks for ROLLS will be key to watch in H2-2019, and may prove the biggest risk to the company’s finances in the short term. Although ROLLS has spent £100M preparing for a hard Brexit (mainly inventory build…), there is still a potential for supply chain disruption in the medium term. This risk probably goes far beyond the fact that ROLLS has net non-£ profits and already trades on WTO terms. That is, at least, what seems to imply the CDS market. The 5y CDS was notably more active since mid-July, as Brexit risk premiums picked up across asset classes. And the CDS felt a bit more subject to the move of those risk premiums (GBP). Indeed, the 5y spread widened by more than 20bp, from c70bp to more than c90bp, while GBP lost c4% vs its main trade partner’s ccy (EUR). The GBP FX moves can trigger flows for some market participants including banks’ CVA desks, beyond the structural exposure ROLLS has to a hard Brexit. The hard Brexit risk generates potential future trajectories on which ROLLS’ financial performance would be pressured, leading to potential rating changes. In terms of agencies’ guidance, MIS said ROLLS needs to achieve adj. leverage c2x in the medium term and FCF +£0.8B in FY-2020 to keep A3. S&P similarly said debt/EBITDA of south 2x is required over the next 12-18 months to keep BBB+. On the FCF, ROLLS management has reaffirmed their guidance this week, at +£1B for FY-2020.