Interactive Investor

Can Rolls-Royce land its ambitious turnaround plan?

9th December 2021 08:40

Richard Hunter from interactive investor

Back where they were a year ago and with year-end looming, Rolls shares remain volatile. Our head of markets picks through the latest trading update and assesses progress in 2021.

Rolls-Royce Holdings (LSE:RR.) is grasping the nettle as best it can, bearing down on those factors within its control.

Its major restructuring programme is the most ambitious of its plans and, so far, the progress has been encouraging. The company is arranging a disposal programme which should realise around £2 billion, which will be used to reduce net debt. Savings from the programme are well on the way to achieving its target of £1.3 billion by the end of 2022, with £1 billion expected to wash through this year. The previously announced reduction of 9,000 roles is also largely complete, with 8,500 now having been achieved.

In another encouraging sign, Rolls has turned into positive cashflow for the third quarter, which has resulted in the group stating that the full-year cash outflow of £2 billion that had previously been predicted, will now be lower than expected.

Further progress is also being seen within its Power Systems unit, which accounts for some 22% of revenues, where a market recovery is in progress, even though supply chain disruptions are a significant headwind. Within the Defence Unit, from which 33% of revenues are derived, a $2.6 billion contract win for B-52 replacement engines should result in a more immediate cash injection of $500 million in the first phase.

However, the Civil Aerospace division remains the area of concern. The unit accounts for 41% of revenues and, has been widely reported, derives much of its income from hours flown on the engines it has provided. The company is putting on a brave face at the current time, pointing to a gradual recovery in international flying, but the latest impact in the form of the Omicron variant resulting in further travel restrictions has come at a difficult time for the company.

Despite the reported improvement which has been seen, flying hours are currently around 50% of 2019 levels, and around 46% in the year to date. Even prior to today’s update, the company had not seen more than a return to 80% of 2019 levels next year, and the latest variant news has forced a decline of some 9% over the last month in the share price.

Indeed, the share price has been subject to some extreme volatility as the pandemic has moved through its various phases. A more recent recovery in the price over the last three months of 16% on improving prospects has led to a gain of 2% over the last year, as compared to a hike of 12% for the wider FTSE100. Over the last two years, however, the shares remain down by 48% and the fact that a dividend cannot be paid until at least 2023 removes another element of investment attraction.

There are signs of progress within its restructuring programme, and the company should emerge as a leaner entity as and when some of the dust eventually settles. At the same time, the strength of the Defence unit in particular is of solace, and a gradual recovery in flying hours would improve the cause over the medium term.

In the meantime, however, the stock remains one only for the most steely and patient of investors, with the market consensus of the shares as a "hold" also implying that the company still has some way to go before a recovery can be called.

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