ii view: what now for Rolls-Royce after shares hit highest since 2018?

Full-year results to 31 December

• Adjusted sales up 21% to £15.4 billion
• Adjusted operating profit of £1.6 billion, up from £652 million
• Net debt down 40% to £1.95 billion
• No dividend payment

Guidance:

• Expects full-year 2024 operating profit of between £1.7 billion and £2 billion

Chief executive Tufan Erginbilgic said: 

“Our transformation has delivered a record performance in 2023, driven by commercial optimisation, cost efficiencies and progress on our strategic initiatives. This step-change has been achieved across all our divisions, despite a volatile environment with geopolitical uncertainty, supply chain challenges and inflationary pressures.

“We are managing the business differently and our significant performance improvement in the year reflects the hard work and focused actions of all our teams. We are unlocking our full potential as a high-performing, competitive, resilient, and growing Rolls-Royce."

• Invest with ii: Open a Stocks & Shares ISA | ISA Investment Ideas | Transfer a Stocks & Shares ISA

ii round-up:

Engine maker Rolls-Royce Holdings (LSE:RR.) today detailed annual 2023 profits and estimates for the year ahead of City forecasts, driven by airline recovery from the pandemic and management initiatives. 

Adjusted 2023 profit of £1.6 billion exceeded analyst hopes for nearer £1.4 billion, with forecast adjusted profit for 2024 up to £2 billion, which is already near management’s prior 2027 target of between £2.5 billion and £2.8 billion.

Shares in the FTSE 100 company rose 8% in post results trading, having come into this latest news up by more than 200% over the last year. They're up 400% since a slump below 70p in October 2022 and now trade at their highest levels since August 2018. By comparison, plane maker Airbus SE (EURONEXT:AIR) is up almost 20% over the past year, and Rolls customer and owner of British Airways International Consolidated Airlines Group SA (LSE:IAG) is down 5%.

Rolls-Royce operates across the three core divisions of civil aerospace, defence, and power systems, with customers including more than 400 airline and leasing companies and 160 armed forces and navies and over 5,000 power generation customers.  

Sales at its civil aerospace division climbed 29% to £7.3 billion, aided by a one-quarter gain in aftermarket sales as well as the delivery of 262 large engines to customers - up from 190 in 2022.

Large engine flying hours for the business recovered 36% year over year to 88% of 2019 levels, with management expecting that to recover further in 2024 to potentially 110% of 2019 or pre-pandemic levels. Rolls is paid by its commercial airline customers depending on how many hours its engines fly.

Defence and power systems sales improved 12% and 16% respectively to £4.1 billion and £4 billion, with profit performances for each aided by product price rises and management’s group-wide push to cut or contain costs. 

Record free cash flow (FCF) of £1.3 billion helped net debt fall 40% to £1.95 billion, with FCF for 2024 forecast by management to come in at up to £1.9 billion, which compares to a 2027 minimum target of £2.8 billion.   

Broker UBS reiterated its ‘buy’ stance on the shares post the results, flagging an estimated fair value of 400p per share. 

ii view:

Tracing its roots back to 1906, Rolls-Royce products today power more than 30 different types of commercial aircraft. Its military engines power some 16,000 planes, helicopters, and submarines, while its Power Systems division sells around 20,000 reciprocating engines annually for marine and industrial applications. 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. 

For investors, global geopolitical tensions such as those in the Middle East and Ukraine could yet escalate, potentially disrupting its airline customers. Costs for businesses generally remain elevated, supply chain disruption persists, while there is still no dividend. 

• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
• eyeQ: Rolls-Royce shares – a case study in macro vs micro
• ISA ideas: out-of-form areas pros think will make a comeback
• ii view: Airbus details special dividend following record orders

On the upside, its civil aerospace division continues to make solid progress given the recovery seen by its airline customers. Around £150 million of its annualised medium-term cost savings target of up to £500 million has been achieved, group net debt continues to fall, while there are hopes that the dividend could soon be reinstated. 

For now, Rolls-Royce shares have come a long way and were easily the best-performing FTSE 100 company in 2023, with a rise of 222%. Despite that, trading momentum and management initiatives look to remain in its favour, arguably giving room for investors to remain cautiously optimistic. 

Positives: 

• Investing in climate change related product innovation
• Reducing net debt

Negatives:

• Uncertain geopolitical outlook
• Dividend payment suspended

The average rating of stock market analysts:

Buy