Rolls Royce – engine flight hours behind target

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Large engine flight hours (EFH) improved to around 50% of 2019 levels, below management’s target of 55% by the end of 2021.

Free cash flow returned in the third quarter, leading the group to improve its forecast of free cash outflow for the full year to less than £ 2 billion.

The divestments are expected to generate around £ 2 billion in cash, with the proceeds going towards debt reduction.

Shares fell 3.7% early in the session.

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Our point of view

The main activity of Rolls Royce (Rolls) is the production and maintenance of aircraft engines, increasingly intended for large aircraft (two-aisle passenger planes). It has been a terrible place to be in a pandemic.

As the pandemic continues to weigh on the travel industry, engine flight hours are around half of normal levels. And the group is set to miss its target of 55% of 2019 levels by the end of 2021. There is still a long way to go to get back to square one, let alone a full-fledged recovery.

Lack of flight hours means customers don’t have their existing engines serviced, but also don’t have the money (or need) to buy new ones. Coupled with very significant and very fixed costs, the net effect will be a new outflow of available cash this year. However, cash flow turned positive in the third quarter, which means that the outflows for the year will be lower than initially expected.

Join the biggest restructuring effort ever undertaken by Rolls. By the end of the year, 8,500 jobs are expected to have been cut. The divestitures are still pending, totaling around £ 2 billion. And the investments were diverted from Civil Aerospace – previously the main division.

The group ended the half year with £ 7.5bn in cash, so we have no immediate concerns on that front – although this cushion comes at a cost. Rolls is not allowed to pay dividends until at least 2023 under its loan terms. Even without this bureaucracy, the group would not be able to pay a dividend because it has a negative net position, which means liabilities outweigh assets.

There is some good news. Rolls boasts a multi-billion pound order book, bolstered by reliable defense contracts. This gives the group excellent visibility on a certain turnover. But since Defense represents less than a third of the group’s overall turnover, this is just a glimmer of hope in an otherwise bleak history.

At one point, we thought the defense business might end up on the block, with money from a sale needed to keep the rest of the business afloat. Fortunately, that danger seems to be receding as more areas are cut off instead. Defense spending is expected to remain robust, and being a “critical” defense provider to the UK and US governments is a great position in our view.

Longer term, Rolls Royce’s scale and very high entry barriers should keep it in good stead – both in defense and in civil aviation. However, assessing this long-term opportunity is a challenge at the moment. Huge asset write-downs mean that traditional valuation metrics – like price / book or price / earnings – don’t tell the full story of Rolls Royce shares. For this reason, we have used the Rolls price / sales ratio in the box below to provide an evaluation touchpoint as it indicates how much the market is willing to pay for each book sold. But it’s not a perfect indicator because it doesn’t factor in debt or profitability – both of which are troublesome for Rolls right now.

The group is at a cyclical low point and while it looks like the worst is over, the lack of a clear profit path and a slower-than-expected recovery in aviation means the future remains uncertain. The bull’s case focuses on specialty products and services and these are long-term attractions. But the medium term looks bumpy at best. And without a dividend to make the wait more palatable, shareholders should be prepared to endure some turmoil.

Rolls Royce key figures

  • Price / sales ratio: 0.96
  • 10-year average price / sales ratio: 1.07
  • Potential dividend yield (next 12 months): 0.0%

All ratios are from Refinitiv. Remember that returns are variable and are not a reliable indicator of future income. Keep in mind that key figures shouldn’t be considered in isolation – it’s important to understand the big picture.

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Trade Update

The projected cost savings of £ 1.3bn by 2022 are on track, with £ 1bn expected for the current fiscal year.

In Civil aerospace, EFH in business aviation remained above 2019 levels and the reopening of some key travel corridors, particularly transatlantic routes, helped EFH move forward. However, installed engine sales and aftermarket shop visits were both lower than last year and were at the lower end of expectations.

Defense performance was in line with expectations as demand remains stable. The group succeeded in winning the contract to replace the B-52 engine. The initial phase, worth £ 500million, is for testing and development. Plus, another deal to power the US fleet of 76 eight-engine planes for the next 30 years, bringing the total contract value to £ 2.6 billion.

Order intake improved in Feeding systems as customer demand picks up. However, disruptions to the global supply chain remain an immediate obstacle.

Learn more about Rolls-Royce shares, including how to invest

This article is original content from Hargreaves Lansdown, published by Hargreaves Lansdown. Unless otherwise stated, estimates, including potential returns, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Returns are variable and not guaranteed. The value of investments goes up and down, so investors could suffer a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No opinion is given on the current or future value or price of an investment, and investors should make up their own mind about any proposed investment. This article has not been prepared in accordance with legal requirements to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting pre-research transactions, but HL has controls (including transaction restrictions, physical and information barriers) in place to manage the transactions. potential conflicts of interest presented by such a transaction. Please see our full non-independent research for more information.


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