ii view: Rolls-Royce's three-week rally is over

The FTSE 100 aircraft engine giant has lost more than a third of its value in 2022. We assess prospects.

Trading update for the year to 31 October

Chief executive Warren East said: 

"The continued recovery in large engine flying hours, record order intake in Power Systems and a resilience in the Defence business give us confidence in the future. Our more agile operations and sustainably lower cost base position us well for the uncertain pace of the recovery from the pandemic, market volatility and changes in economic conditions.”

ii round-up:

Aircraft engine maker Rolls-Royce Holdings (LSE:RR.) today reaffirmed its full-year forecasts, despite battling headwinds like rising costs and supply chain challenges which left it with higher levels of inventory.

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The FTSE 100 engineer, whose chief executive is leaving soon, continues to expect low-to-mid-single digit underlying revenue growth for the full year, with profit margin broadly in line with last year’s 3.8%. Civil aircraft engine deliveries are up on last year but are at the lower end of management’s expected range.

Rolls shares fell by more than 5% in UK trading having come into this latest announcement already down by close to a third. Plane maker Boeing Co (NYSE:BA), which Rolls engines regularly power, are down by around a quarter in 2022, while budget airline easyJet (LSE:EZJ) is down by two-fifths. 

Rolls operates across the four divisions of aerospace, power systems, defence, and new markets. Flying hours for its aircraft engines powering airlines hit 65% of their pre-pandemic 2019 level in the four months to the end of October.  

Order intake for its power systems division proved a record, including 500 engines for the UK's Boxer armoured vehicle along with products for four new German Navy frigates. 

Its new markets business continued to invest in technologies to assist in preventing climate change, including clean aviation projects and programmes. 

In September, Rolls completed its targeted £2 billion of business sales, using the proceeds to reduce debt due by 2025. It continues to target an investment grade credit profile in the medium term supported by free cash flow generation. 

Annual results will likely be announced in February.   

ii view:

Rolls has customers in over 150 countries, comprising more than 400 airlines and leasing customers, 160 armed forces and navies, and over 5,000 power and nuclear customers. Its New Markets division is looking to offer a new low-cost nuclear reactor design, around one-tenth the size of a conventional nuclear generation site, providing low-carbon energy. Its Power Systems business is working on developing hydrogen powered engines. 

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For investors, a highly uncertain economic outlook for its customers and a cost-of-living crisis now casts a shadow over future airline and traveller demand. Costs for Rolls, like industry generally, are rising, while supply chain challenges are causing inventory levels to rise. The dividend remains suspended, while the pending change in leadership provides some uncertainty. 

On the upside, business disposals have enabled a reduction in debt, some recovery is being seen at its commercial airline customers following the pandemic, while management initiatives to help contain rising costs continue to be pursued. 

On balance, and while scope for caution remains, business diversity, a reset cost structure and a focus on product innovation demonstrate that Rolls is doing everything in its control to improve performance over the longer term.  

Positives: 

• Cost containment initiatives  
• Investing in climate change related product innovation

Negatives:

• Highly uncertain economic outlook
• Dividend payment suspended

The average rating of stock market analysts:

Hold