Interactive Investor

Rolls-Royce: what’s behind the stunning rally?

23rd February 2023 13:11

by Graeme Evans from interactive investor

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Rolls-Royce shares are flying after its new boss turbocharged 2022 results with some bullish guidance. Our City expert examines today’s developments.

Rolls-Royce engine 600

A Rolls-Royce Holdings (LSE:RR.) capable of “materially higher profit, cash flows and returns” was music to the ears of shareholders today as the engine giant’s new boss made an instant impression.

Tufan Erginbilgic’s first set of results and revelation that a transformation plan is already moving at pace inspired the best performance for shares in two years.

Rolls, which languished at below 70p in October, hit a high of 134p during a stunning session when four times the usual daily volume of shares had been traded by lunchtime.

More details on Erginbilgic’s plans are due later in the year, including the key points from a strategic review designed to focus investment on the most profitable opportunities.

In the meantime, the company is finally benefiting from favourable tailwinds as a recovery in engine flying hours in civil aerospace led to better-than-expected 2022 results.

The most important statistic concerned £502 million of free cash flow, which compared with the City’s £64 million forecast and an outflow of £1.5 billion the previous year. Aided by disposals, it means net debt is down to £3.3 billion from £5.2 billion in 2021.

Guidance for the current year also impressed as Rolls signalled an operating profit of between £800 million and £1 billion, up from the better-than-expected £652 million reported today.

Free cash flow is seen in the range of £600 million and £800 million as the reopening of China’s economy means Rolls expects large engine flying hours at 80%-90% of their 2019 pre-Covid level, compared with 65% in 2022.

Total shop visits are also set to rise from 1,000 to 1,200-1,300 amid greater utilisation of aircraft such as the A330, powered by Trent 700 engines with an average age of 11 years.

These remain early days in the turnaround, however, with dividend payments still off the table as the company focuses on returning to an investment grade credit rating.

And it was only last month that Erginbilgic likened the business to a burning platform and said that the current performance was unsustainable.

He wants to create a “winning culture”, with a shared determination to deliver cash and reduce debt as Rolls focuses on improving efficiency and commercial outcomes.

The former BP executive said today: “Our people take tremendous pride in our innovation and engineering solutions. Together, we must now move at pace and harness that pride to create a high-performing, growing and competitive business.”

Extensive work has already taken place to benchmark the company’s performance against its peers, with the conclusion that there is “significant scope for us to deliver materially higher profit, cash flows and returns”. 

These comments provided a major lift to stock market confidence today after a drawn out Covid recovery that required November 2020’s heavily discounted £2 billion rights issue. The fundraising offered existing investors the chance to buy shares at just 32p a share.

While the company’s businesses in defence and power systems have performed well for some time, they have been unable to compensate for the slower-than-expected return to profitability and free cash flow in civil aerospace.

Today’s operating profit in civil aerospace amounted to £143 million at a 2.5% margin, versus a loss of £172 million in 2021 as engine flying hours rose 35% and deliveries improved 15%.

Order intake in the defence business of £5.4 billion compared with £2.3 billion in 2021, but operating profit of £432 million at a 11.8% margin was down slightly due to the non-repeat of a large spare parts order the previous year.

Power systems orders were a record £4.3 billion, some 29% higher than the year before and leading to improved profits of £281 million at a 8.4% margin.

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