ii view: Rolls-Royce was a winner in 2023 but what will 2024 bring?

Trading and strategy update

• Current full-year 2023 forecasts unchanged

Medium-term guidance to 2027:

• Now targeting operating profits of between £2.5 billion and £2.8 billion
• Targeting free cash flows of between £2.8 billion and £3.1 billion
• Expects to make business sales of between £1 billion and £1.5 billion 

Chief executive Tufan Erginbilgic said: 

"Rolls-Royce is at a pivotal point in its history. After a strong start to our transformation programme, we are today laying out a clear vision for the journey we need to take and the areas where we must focus. We are creating a high performing, competitive, resilient and growing Rolls-Royce that will have the financial strength to control and shape its own destiny. 

“We are confident in our ability to achieve these ambitions and have a clear and granular plan to deliver on our targets. We have made significant progress, with 2023 profit and cash forecast to be materially ahead of 2022.”

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ii round-up:

Rolls-Royce Holdings (LSE:RR.) operates across the three core divisions of civil aerospace, defence, and power systems. 

It 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. 

During 2022, its Civil Aerospace division generated its biggest slice of revenue at around 45%, followed by Defence at 29% and Power systems at 26%. 

For a round-up of this latest trading update announced on 28 November, please click here. 

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.

Along with its three core divisions, 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, geopolitical tensions globally, including those in the Middle East and between the West and China, have the potential to disrupt air travel given any military escalation, and costs generally for businesses remain elevated. A current share price-to-free cashflow ratio sat comfortably above the three-year average suggests the shares are no longer cheap, while there is currently no dividend.      

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On the upside, there's been a significant recovery in flying hours for its large engines following the pandemic, with potential for further upside. Medium-term cost savings of between £400 million and £500 million are being pursued, a focus on improving its finances has recently seen its credit rating upgraded to BB+ - just one level below investment grade - while there are hopes that the dividend will soon be reinstated. 

It would not be surprising to see a period of consolidation for the share price, or at least see the pace of growth slow. A lot has been baked into Rolls' valuation, and management needs to deliver on promises and start achieving ambitious targets. That said, Tufan Erginbilgic has had a remarkable start to his tenure and has proved he can get results. He has the backing of many in the City and, if he can demonstrate further progress in 2024, there could be extra rewards for long-term investors.

Positives: 

• Transformation plan  
• Investing in climate change related product innovation

Negatives:

• Uncertain economic outlook
• Dividend payment suspended

The average rating of stock market analysts:

Buy