By Eleanor Duncan
LONDON, Aug 13 (IFR) - Two of the UK's best-known corporates suffered rating downgrades on Tuesday, with the agencies citing higher leverage in both cases.
Rolls Royce and Vodafone were cut a notch by Moody's and Fitch respectively, with the move against the former in particular affecting its bonds.
Rolls Royce's spreads gapped out after Moody's cut the UK engineer's debt rating to Baa1 (stable).
The company's euro bonds widened out by up to 4bp.
Moody's analysts said Rolls Royce had negative free cashflow for the first half of the year. The core business had a cash outflow of £391m, due largely to seasonal timing of engine deliveries.
Analysts also pointed to the company's leverage of 5.3x. Rolls Royce could be upgraded if this was reduced towards 2.5x, analysts said. Moody's expects leverage to reduce only towards 4x over the next 12-18 months.
Moody's said it expects that "target free cashflow in 2019 will include working capital gains, which are not considered sustainable" - and that the same would be true of its 2020 target.
However, the analysts said they expect Rolls Royce to improve earnings and cashflow - albeit slowly.
Moody's said the company has made several important steps towards improving longer term performance, including reducing losses on the sale of large commercial engines. It also has strong levels of liquidity.
Rolls Royce has been building up inventory to cope with any supply-chain disruptions caused by Brexit, said Warren East, the chief executive, earlier this month. The company expects a "significant improvement" in cash in the second half as that inventory is unwound, East said.
The company hit the headlines on Monday after media reports that fragments of an engine fell from a Norwegian Boeing 787 Dreamliner near Rome, Italy.
Rolls Royce is rated A- (stable) by Fitch.
Vodafone was downgraded by Fitch to BBB (stable).
Fitch said the downgrade was driven by the largely debt-financed purchase of Liberty Global's operations in Germany, the Czech Republic, Hungary and Romania for €18.4bn.
Vodafone has been seeking to reduce debt through dividend payment cuts and asset sales, including the disposal of Vodafone New Zealand, Fitch said.
Fitch is following in the other rating agencies' footsteps. S&P already has Vodafone at BBB (stable) after downgrading the company earlier this month. Moody's rating is Baa2 (negative).
(Reporting by Eleanor Duncan, editing by Sudip Roy, Julian Baker)
((Eleanor.Duncan@thomsonreuters.com; +44 20 7542 5016;))