ii view: why Rolls-Royce shares are the biggest blue-chip faller

This aero engine maker has burnt cash of £3 billion with another £1 billion forecast in the second half. 

First-half trading update

• Free cash outflow of approximately £3 billion
• Widebody engine flying hours (EFH) down approximately 50% in H1 and 75% in Q2
• Approximately £300 million of cost savings achieved 
• Cash liquidity up 21% from Q1 to £8.1 billion

Guidance:

• Forecasting widebody full-year EFH to be down in the region of 55%
• Expected second half free cash outflow of approximately £1 billion

Chief executive Warren East said:

"These are exceptional times. The Covid-19 pandemic has created a historic shock in civil aviation which will take several years to recover. We started this year with positive momentum and strong liquidity and acted swiftly to conserve cash and cut costs to protect Rolls-Royce during the pandemic. We are taking steps to resize our Civil Aerospace business to adapt to lower medium-term demand from customers and help secure our future. 

"This means we have had to take the very difficult decision to lose people who have helped us become the company we are and who have been proud to work for Rolls-Royce. It is my first priority to treat everyone - whether they are leaving or staying - with dignity and respect. We will take the lessons of how we have dealt with this unprecedented challenge with us and position ourselves to emerge as an even stronger company in the future."

ii round-up:

Aircraft engine maker Rolls-Royce (LSE:RR.) today reported first-half cash burn of £3 billion as the airline industry came to a near stand still in the wake of the coronavirus pandemic. 

Widebody engine hours flown halved in the half-year and fell by 75% in the second quarter. Rolls is paid by its airline customers depending on how many hours they fly. Despite some expected increase in flights over coming months as lockdown restrictions ease, a further £1 billion of cash burn is expected in the second half, worse than City forecasts.

Rolls-Royce shares fell by more than 8% in early UK market trading and are down by more than 60% year-to-date. Airbus (EURONEXT:AIR) and Boeing (NYSE:BA), whose planes Rolls engines regularly power, are both down by 50% and 45% respectively in 2020. Shares for customer IAG (LSE:IAG) are down more than 65%.  

Rolls' delivery of new widebody engines for the year remains at 250, down from a previous estimate of 450 units. Moves to conserve cash and cut costs have included a planned loss of 17% of its overall workforce or 9,000 staff and suspending the dividend payment. 

Away from civil aerospace, trading for its power systems division is mixed. Customers in industrial markets such as oil & gas and mining have suffered reduced volumes, while demand for smaller yacht engines has fallen as some marine yards have closed. But the rest of its marine business has performed relatively robustly. Long-term demand growth for reliable power solutions is expected to remain intact.

Its defence business has stayed resilient, fuelled by demand from key government customers. In the US, it is currently contending for the new B-52 military engine opportunity. 

First-half results are scheduled for 27 August.

ii view:

Rolls-Royce customers include more than 400 airlines and leasing customers, 160 armed forces, 70 navies, and over 5,000 power and nuclear customers.

The civil aerospace engine business accounts for just over half of group sales. The Covid-19 pandemic is now hitting this business hard. Flying hours in April were down 80% compared to April 2019. Airlines globally are now cancelling new aircraft deliveries, hitting demand for new engines. A total of 250 are now scheduled in 2020, down from a previous 450 – 130 have been made to date. 

For investors, progress in restructuring the company prior to Covid-19 had been seen. As a supplier to the volatile airline industry, Rolls is experienced in dealing with the ebbs and flows. A business model geared towards aftersales and reliant on growing flight hours has long been established. Around half of 2019 revenues came from the provision of aftermarket services.

But now, and despite measures to resize the group’s cost base and conserve cash under Covid-19, those aftermarket sales or income remain severely pressured. In all, and with the timing of any return to normal service for the airline industry impossible to predict, there appears to be no rush for investors to accumulate holdings. 

Positives: 

• Diversity of product and geographical end-markets
• Up to £1 billion of 2020 cost savings on target

Negatives:

• Exposure to the volatile airline industry
• Final 2019 dividend payment cancelled

The average rating of stock market analysts:

Hold