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In need for Cash

30 March 2020 by jbchevrel

Rolls-Royce (RR) 5-year CDS has been the worst-performing single-name in the Main today. the CDS was wider by +45bp, while other names were -35/+25. The aggregate fair value (NAV) was wider by just +4bp on s33. RR 5y CDS had started the COVID19widening in low 90s. indeed, the Dec24 contract had closed at 93bp on Feb 21st. Tonight we closed +342bp wider than back then (incl. the roll impact), at 435bp. Over the same time period (incl. the roll impact), the itraxx Main has widened by +55bp, from 42bp for Main32 on Feb 21 close to 98 today for Main33. What is also notable in today’s bearish move, is that the RR curve has decently flattened. Indeed, we mark the 3s5s flatter by -45bp at 60bp and the 1s5s flatter by -51bp at 165bp. This is as RR are facing a liquidity crisis as the COVID19-linked collapse in air travel threatens ~1/2 of RR £15bn underlying revenue. Airlines have with RR some “power by the hour” contracts, i.e. paying for the number of flight hours on RR engines. RR revenues have collapsed as demand for air travel plunged and many borders closed, around the world. The Telegraph reported that data from the aviation analyst Cirium showed that the number of wide-body aircraft with RR engines flying plunged from 1,580 at the start of the year to 468 on March 25. Apparently, daily flight hours have fallen from 20,421 to 4,657 over the same period. The fact that RR engines are more widely used on big planes (transcontinental flights) makes it marginally more affected, than if they equipped shorter intra-continent flights. Adding to the shock in demand, there is the supply disruption to consider: last week, RR 7.5k UK manufacturing staff were sent home while management works out how production can be continued without contamination risk. RR had a cost-cutting plan going on, earlier than the COVID19breakout. The dividend and executive pay are likely to be cut. RR balance sheet was already under pressure. It had expected to have a negative CF in H1 and faced £2.4bn costs to deal with Trent 1000 engine-related issue, as discussed previously in this blog. Recently, RR drew down £2.5bn of funding to boost its liquidity to £7bn. A potentially important aspect is that RR defence business is strategically important for the UK. RR is indeed building engines for the RAF and nuclear reactors for Royal Navy submarines. So we might see some government intervention, should things go even more sour. Actually, RR was reported to have spoken with the UK government about tapping emergency funding, along with banks about further support. the timing will be key, and if demand takes long before reverting, RR will likely need to raise cash. This is not in RR communication yet, a spokesman for RR said: “We have a robust financial position and are closely monitoring the situation and taking prudent measures to conserve cash. Our good starting position and the measures we have taken, and will continue to take, give us confidence in the ongoing financial resilience of our business.”