ii view: Rolls-Royce stays on course to pump up profits

An ongoing transformation programme, a recovering airline sector and push to develop products under the transition to net carbon zero. Buy, sell, or hold? 

Trading update from 1 January to 30 April

Chief executive Tufan Erginbilgic said: 

"We are transforming Rolls-Royce into a high quality and competitive business with a strong balance sheet and growing profit, cash flows and returns. We are already benefitting from the actions we are taking as well as recovery and growth in our end markets. 

“We announced several changes to the executive team in March to support the transformation, adding leaders with proven track records of delivery and high-performance. We are making good progress and our financial performance year-to-date is in line with expectations.”

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ii round-up:

Aircraft engine maker Rolls-Royce Holdings (LSE:RR.) today detailed trading for the first four months to the end of April which had remained in line with prior expectations. 

Large civil engine flying hours of 83% of those flown in the pre-pandemic 2019 had been seen, with full-year 2023 adjusted operating profit still expected to come in at between £800 million and £1 billion, up from £652 million in 2022. Rolls is paid by its airline customers depending on how many hours its engines fly.

Shares in the FTSE 100 company fell 6% having almost doubled over the last year. Rival aerospace component marker Melrose Industries (LSE:MRO) is up by almost a third over that time, while shares for Rolls' customer and owner of British Airways, International Consolidated Airlines Group SA (LSE:IAG), has gained by around a quarter. The FTSE 100 index itself is up by close to 6%. 

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. 

New business wins for its Civil Aerospace division included its biggest ever order of 68 Trent XWB-97 engines for Air India, while revenue growth for its Power Systems business had been aided by demand for aftermarket services. 

The Defence business during the period won the contract to supply engines for submarines being made by BAE Systems (LSE:BA.) for Australia under the so called AUKUS agreement – a pact between the UK, US, and Australia to help preserve a free and open Indo Pacific region. 

Broker UBS summarised the update as offering little new detail although flagged a ‘buy’ rating on the shares with an estimated fair value price target of 200p per share. 

First-half results are scheduled for 3 August. 

ii view:

Tracing its history back to 1906, Rolls today employs over 35,000 people with customers in more than 150 countries. 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. Civil Aerospace division generates its biggest slice of revenues at around 45%, followed by Defence at 29%, and Power systems at 26%. 

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Strategic pushes under its 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 will also be carried out, with its New Markets business possibly coming under the microscope. 

For investors, economic uncertainty including possible further interest rate rises should not be ignored. Exposure to the often volatile and cyclical airline industry deserve thought, as do elevated costs for businesses generally and the still halted dividend payment. 

More favourably, a broad recovery for the airline industry following the pandemic continues to unfold. Increased geopolitical tensions between the West and Russia and China have seen defence considerations moving up the political agenda, while its ongoing focus on reducing net debt is likely moving it closer to potentially restoring the dividend payment. 

On balance, and while some caution remains sensible as more good news is built into the share price, underlying trading momentum looks to remain in the company’s favour which should keep longer-term investors happy.  

Positives: 

• New CEO initiatives  
• Investing in climate change related product innovation

Negatives:

• Uncertain economic outlook
• Dividend payment suspended

The average rating of stock market analysts:

Strong hold