Interactive Investor

ii view: Rolls-Royce shares rocket 20% after blockbuster update

26th July 2023 11:23

by Keith Bowman from interactive investor

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This aero engine maker's shares were already up by more than 60% year-to-date coming into this latest news. Now they're at their highest since March 2020. Buy, sell, or hold?

Rolls-Royce factory 600

First-half trading update to 30 June

  • Expects operating profit of between £660 million and £680 million, up from £125 million last year

Guidance:

  • Now expects full-year adjusted operating profit of between £1.2 billion and £1.4 billion, up from its previous estimate of between £0.8 billion and £1 billion 

Chief executive Tufan Erginbilgic said: 

"Our multi-year transformation programme has started well with progress already evident in our strong initial results and increased full year guidance for 2023. There is much more to do to deliver better performance and to transform Rolls-Royce into a high performing, competitive, resilient, and growing business. 

“Despite a challenging external environment, notably supply chain constraints, we are starting to see the early impact of our transformation in all our divisions. Better profit and cash generation reflects greater productivity, efficiency and improved commercial outcomes."

ii round-up:

Aircraft engine maker Rolls-Royce Holdings (LSE:RR.) today significantly upgraded its profit expectations as it now benefits from both strong product demand and the early impact of its cost saving and transformation programme. 

Underlying operating profit for the six months to June is now expected by management to be between £660 million and £680 million compared to City expectations of around £328 million. The full-year forecast is now for profit between £1.2 billion and £1.4 billion versus current analyst estimates of £934 million. 

Shares in the FTSE 100 company soared by around a fifth to over 185p per share having been below 70p in October last year. They're up 86% so far in 2023 compared to a gain of 1% for the FTSE 100 index itself. Plane maker Airbus SE (EURONEXT:AIR) is up around a fifth year-to-date, similar to airline International Consolidated Airlines Group SA (LSE:IAG)

All three of Rolls' divisions are now benefiting from the joint tailwind of robust demand and early transformation benefits. 

Higher aftermarket profitability and increased spare engines sales are expected to push first-half profit for its Civil Aerospace division to around £400 million, compared to last year’s interim loss of £79 million. 

Strong demand and increased prices at its Defence business will likewise now see interim profit come in at around £260 million, up from £189 million. Power Systems profit is expected to rise marginally to £120 million from £119 million for the first half, although with pricing actions raising profit margins during the second half. 

Full-year free cash flow is now expected to be between £0.9 billion and £1 billion, up from management’s previous estimate of £600 million to £800 million, improved by higher profits. 

First-half results are scheduled for 3 August. 

ii view:

Rolls has more than 15,000 jet engines in service globally powering more than 30 different types of commercial aircraft. Its military engines power some 16,000 planes, helicopters, and vessels, while its Power Systems division sells around 20,000 reciprocating engines annually for marine and industrial applications. 

Along with the three divisions of Civil, Defence and Power Systems, it also operates a small New Markets division, focused on opportunities for the transition to net zero such as developing small low-cost nuclear reactors and hydrogen powered engines. Strategic pushes under its relatively new chief executive include simplifying the business, increasing efficiency, potentially via further cost cuts, and injecting new vigour into its culture including hiring new executives. A review of investment opportunities going forward will also be carried out, with its New Markets business possibly coming under the microscope. 

For investors, the tough economic backdrop including rising interest rates cannot be forgotten. Exposure to the often volatile and cyclical airline industry warrants consideration, as do elevated costs for businesses generally and the lack of dividend payment. 

On the upside, travel demand following the pandemic is now robust and the war in Ukraine is a tailwind for defence sales. The relatively new CEO’s transformation push is reaping benefits, while management’s ongoing focus on reducing debt is likely moving it closer to restoring the dividend payment. 

For now, and while some caution appears sensible following such a strong share price performance, fundamentals look to remain in the company’s favour, with long-term investors likely to find Rolls an attractive long-term option below pre-Covid prices.  

Positives: 

  • CEO initiatives  
  • Investing in climate change related product innovation

Negatives:

  • Uncertain economic outlook
  • Dividend payment suspended

The average rating of stock market analysts:

Cautious buy

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