OREANDA-NEWS. Fitch Ratings has identified five rating critical factors to look for in Rolls-Royce Holdings plc's (A/Negative) annual results and 2016 outlook announcement on Friday. Fitch believes that these key indicators will reflect whether the company can achieve a recovery and sustainable improvement in its financial profile.

The Outlook on the company's rating has been Negative since November 2015, due to the deterioration in key financial metrics, such as gross and net leverage as well as free cash flow generation.

To revise the Negative Outlook, Fitch would look to the likelihood of an enduring improvement in the financial profile in 2017 and beyond, as we believe that the group's results in 2016 will remain weak and not in line with the current rating. In addition, we consider it possible that a further profit revision for 2016 will be announced this week, stemming from the identification of further operational efficiency improvement requirements. We will re-assess our view on the group's credit profile depending on the outlook and announcements made by the company.

The first key factor to watch will be the restructuring plan, which Fitch expects to be announced in conjunction with the results to address the presently high and inflexible cost structure and weaknesses in certain markets. Key to our assessment of the plan is the likelihood of the expected increase in core earnings that the measures are anticipated to bring over the medium to long term. Fitch will also look at the expected related cash outlay in 2016 and 2017, in order to ascertain whether the amount is commensurate with expected earnings improvements, based on past restructuring actions in the sector.

Secondly, Rolls Royce has historically provided more opaque divisional reporting and guidance than its peers. Depending on the extent of the promised improvement in transparency from the company, particularly with regard to guidance, the predictability of financial results may improve, thus lessening rating uncertainty. Fitch also believes that broad medium-term guidance could be provided by Rolls Royce, given the large order book and long lead times on most programmes.

Thirdly, a commitment to a firm and comprehensive set of financial targets will suggest a determination to improve the financial profile in a specified time frame and possibly to a rating target. Fitch will focus on the viability of the financial strategy, with particular emphasis on cash conversion and working capital management as well as cash deployment, especially with regard to capex and the shareholder remuneration policy. To date, the company has been committed to a strong investment grade rating and operated a capital structure broadly in line with the 'A' category.

Fourthly, the strategic review should shed light on any possible realignment of the company's portfolio of businesses and identify sectors and areas which the group intends to focus on, as well as acquisitions and disposals. The extent of any large-scale M&A activity may have a rating impact as it could alter the financial profile, depending on the funding structure of acquisitions and proceeds deployment decisions. It may also impact the company's business profile, which at present we view as highly supportive of the rating.

Fifth, should the outlook for key markets worsen, and a recovery in these markets beyond 2016 not be expected, the prospect of Rolls Royce improving its margins, while also attempting to improve the flexibility of its cost structure, may take far longer than currently anticipated, thus placing pressure on the rating. Fitch already factors into its ratings the current weaknesses in certain end-markets, such as marine and business jets, as well as the inherent cyclicality related to some large aerospace programmes, all of which will have a negative effect on profitability in 2016.