Fitch Ratings says the £671 million fine that Rolls-Royce Holdings (A/Negative) will pay over 2017 - 2021 as part of its settlement with various regulatory bodies in the UK, the US and Brazil relating to historical bribery and corruption practices will not, in itself, have a material impact on the key credit metrics underpinning the rating of the company.
Fitch estimates that the effect on gross leverage will be minimal as these cash payments are likely to be made chiefly out of the group's ample cash reserves (£2.3bn at end-1H16). The negative effect on net leverage from the payments is estimated by Fitch to be around 0.3x, which is not significant. The payment of the fine will be spread over the coming five years, with £293m in 2017 and between £100m and £150m in each of 2019-2021.
Fitch does not believe that the company's capacity to de-leverage beyond 2017 will be materially affected by the outflows related to the payment of the fines. Fitch expects the group's free cash flow (FCF), which was negative in both 2014 and 2015, to improve significantly over the coming years to over 3% of revenue, thus providing the ability to reduce debt levels. The expectation that debt will be reduced from FCF generation is a key assumption under the current rating.
Fitch also assumes that the underlying cash flows of the company, as measured by the funds from operations (FFO) margin and which Fitch estimates was around 9% for 2016, will rise to above 11% over the coming years as a consequence of improvements in the cost structure and the absence of large restructuring charges. Fitch does not believe that the introduction of a new accounting standard (IFRS 15) on the timing of revenue and profit recognition from 2018 will have a meaningful impact on the FFO margin.
Underpinning the present rating is Fitch’s assumption that key credit metrics, which have been weak over the past two years as a result of some market deterioration and unfavourable product mix, will improve over the coming two to three years and return to levels that are in line with the 'A' rating. The Negative Outlook reflects Fitch's view that this improvement may not occur at the pace necessary to maintain the 'A' rating.
Fitch will monitor the company's 2016 results announcement on 15 February, in particular the accompanying outlook statement for 2017, and update its assumptions and forecasts, to ascertain whether the company remains on track to improve these key ratios over the next two to three years.
The rating agency added that the announced settlement could also impact the company's business profile and corporate governance. Further investigations in other jurisdictions may yield adverse findings, which could limit the company's ability to attract new business. Positively, Fitch acknowledges that recent changes in senior management reduce the risk of further corrupt practices.