ii view: Rolls-Royce reports a surprise profit

Restricted international travel is hurting but business sale talks are progressing. Buy, sell, or hold?

First-half results to 30 June 2021

• Underlying operating profit of £307 million, up from a loss of £1.63 billion in H1 2020
• Revenue down 9% to £5.16 billion
• Cash outflow of £1.17 billion, improved from an outflow of £2.86 billion 
• Expects to achieve £1 billion of savings in 2021
• Liquidity of £7.5 billion including £3 billion in cash

Chief executive Warren East said: “Our continued focus on the elements within our control, together with a good performance from Defence and order intake recovery in Power Systems have enabled us to deliver solid progress in the first half. 

“The benefits of our fundamental restructuring programme in Civil Aerospace are evident in our reduced cash outflow and improved operational efficiency. This leaner cost base together with a strong liquidity position gives us confidence in our ability to withstand uncertainties around the pace of recovery in international travel and benefit from the eventual rebound.”

ii round-up:

Engine maker Rolls-Royce (LSE:RR.) today reported a surprise profit but warned that the pandemic-hit international aviation industry is not set to recover until after 2022.

Adjusted operating profit of £307 million contrasted with analysts’ expectations for a loss of around £250 million. The return to profit was aided by ongoing aggressive cost-cutting and favourable product delivery timings at its defence business. 

Rolls-Royce shares gained more than 3% in UK trading leaving them down by around 6% since pandemic market lows in March 2020.

Shares for plane-makers Airbus (EURONEXT:AIR)and Boeing (NYSE:BA), which Rolls' engines regularly power, have both more than doubled in that time. Shares for airline customer International Consolidated Airlines (LSE:IAG) are up by around a quarter. 

Large engine flying hours of 43% of those achieved in pre-pandemic 2019 are up from the 34% flown during the second half of 2020. Rolls is paid by its airline customers depending on how many hours its engines fly.

Management expressed confidence that when border restrictions are lifted the recovery of international travel will accelerate. Rolls had already seen a return to 2019 levels in flying activity for its cargo aviation engines and for large engines operated on domestic flying routes.

A business disposal programme to raise at least £2 billion and to strengthen its finances is ongoing. It recently sold its Norwegian marine engine maker Bergen for €110 million (£93 million) including cash held. 

Talks regarding the sale of its Spanish turbine blade-maker ITP are continuing. A rumoured sale price of €1.6 billion (£1.36 billion) would significantly aid management’s £2 billion disposal goal.  

ii view:

Rolls-Royce operates across the three divisions of civil aerospace, power systems and defence. In 2019, civil aerospace generated just over half of all sales, power systems just under a quarter and defence the rest. Revenues for its core civil aerospace business fell by 37% over 2020, hit by the grounding of many of its engines. Losses for 2020 mounted to £4 billion compared to a profit of £306 million in 2019.

Actions that management can control are progressing. Cost savings of £1 billion are on track during 2021. A cash outflow of £1.17 billion is much better than the £2.86 billion outflow seen in the first half of 2020. Business disposals to raise cash and help reduce increased debt remain ongoing. It expects to sell its civil nuclear instrumentation and control business later this year.

For investors, management caution regarding the return of international travel is not to be ignored. Pandemic uncertainty remains high. Vaccination progress is still to be made in parts of the world and the spread of the Delta variant offers an added worry. 

More favourably, guidance regarding a cash outflow of £2 billion for the full year 2021 was reiterated, a marked improvement from £4.2 billion over 2020. Group liquidity stands at £7.5 billion with management hopes to turn cash flow positive in the second half of 2021 remaining. In all, while a sizeable dose of caution is still required, high-risk long-term investors might now see opportunity emerging. 

Positives: 

• Successfully raised £5 billion 
• Ongoing cost saving programme

Negatives:

• Highly uncertain outlook due to Covid-19
• Dividend payment suspended

The average rating of stock market analysts:

Hold