ii view: Rolls-Royce looks to power an energy transition

Innovation and pro-active management looks to offset a Covid headwind. Buy, sell or hold?

11-month trading update to 30 November

Chief executive Warren East said: 

"We are delivering on the elements within our control and are focused on our commitments. We have achieved good results with our fundamental restructuring programme, as we sustainably reduce costs and deliver a leaner and more efficient company and are firmly on course to complete our disposals programme. 

While external uncertainties clearly remain, we have seen continued gradual recovery in our Civil Aerospace business, a growing order book in Power Systems and have secured a significant contract win in Defence. 

We are investing in the net zero technologies and solutions that we need across the group to grasp the tremendous commercial opportunity of the global energy transition and drive long-term value. This all underpins our strategy of creating a better quality and more balanced business which can deliver significantly improved returns and cash flow into the future."

ii round-up:

Rolls-Royce (LSE:RR.) operates across the three divisions of civil aerospace, power systems and defence.

It has customers in more than 150 countries, comprising more than 400 airlines and leasing customers, 160 armed forces and navies, and more than 5,000 power and nuclear customers.

For a round-up of this latest trading update, please click here.

ii view:

Civil aerospace generates Rolls Royce’s biggest slug of sales at around two-thirds. Rolls is paid by its Commercial airline customers depending on how many hours its engines fly. Next comes Defence, accounting for around a third of sales, and then Power Systems. Earlier in the year the defence division won a £1.9 billion contract to supply the US Air Force’s B-52 bomber fleet with engines and parts for the next 30 years. 

More recently, the Qatar Investment Authority (QIA) agreed to invest £85 million in Roll’s newly established separate Small Modular (nuclear) Reactors (SMR) business in return for a 10% share stake. SMR Ltd was only established in November during the COP 26 climate change conference. It is funded by British Nuclear Fuels (BNF) Resources UK Limited, Exelon Generation Ltd, Rolls Royce and now the QIA. It aims to design and deliver a new low-cost nuclear reactor design to provide low-carbon energy. A single power station will occupy around one tenth of the size of a conventional nuclear generation site and power approximately one million homes.

For investors, a Covid clouded outlook persists, with the new Omicron variant spreading fast. Losses for Covid-hit 2020 mounted to £4 billion compared to a pre-pandemic profit of £306 million in 2019, and the dividend remains halted. 

On the upside, Rolls raised £2 billion from a rights issue last year, a major cost saving programme is ongoing and the previously agreed €1.7 billion (£1.5 billion) sale of its Spanish turbine blade-maker ITP, which is expected to complete in the first half of 2022, leaves it on the verge of achieving its £2 billion disposal target to reduce debt. Improved trading has also aided a return to positive free cash flow in the third quarter, while its stake in the new SMR business offers long-term growth potential. In all, and while the ups and downs of the pandemic cause share price volatility, Roll’s innovation and proactive management arguably make the shares worthy of ongoing long-term support. 

Positives: 

• Successfully raised £5 billion 
• Ongoing cost saving programme

Negatives:

• Covid-19 clouded outlook
• Dividend payment suspended

The average rating of stock market analysts:

Hold