24 Feb 22. Despite announcing that CEO Warren East is to step down at the end of this year and that having returned to profitability following the trauma of the C-19 pandemic that has caused so much havoc on the global aerospace and airline industries, operating margins is likely to eb broadly unchanged this year on single digit increase in revenues, Rolls-Royce share price deserved much better than to have been hammered down by 18% in early morning trade.
Since taking over as CEO of Rolls-Royce in July 2015 Warren East has achieved remarkable success in sorting the many extremely difficult and complicated durability issues around the larger Trent 1000 engine that have now been fully resolved and that were to be followed two years ago by the huge devastation on the commercial airline industry as a result of Covid 19.
FY21 results may well be a shadow of the ultimate potential improvement that is likely to be seen from Rolls-Royce as benefits of fast action taken that Warren East and his team have been driven through the company and as it has been forced to adapt to changing business conditions, but they are nonetheless extremely important markers in the rebuilding of this fine and important company.
And while I can well understand the market being shocked at Warren East’s decision to stand down at the end of this year it needs to be remembered that he has during his term achieved so much and that within this difficult process, he has not only turned round the fortunes of the company but also laid the groundwork and investment for what I regard as being a very different company in the post COVID years that hopefully lie ahead. Perhaps then, markets should not have been quite so surprised as they were that having done such a difficult job of work for what will have been seven and a half years by the time he steps down in December, he felt that now was the right time to hand over.
Neither am I in any doubt that the new Chairman of Rolls-Royce, Anita Frew will take time to ensure that the right person is chosen to take Rolls-Royce forward into a new era. Of course, challenges and some risks remain and Warren East will continue to lead the company through what will be a very important period in the recovery process through the rest of this year. Consistency is important but while there is clearly necessary caution against over expectation present in comments accompanying these results, I take the view that FY22 will see Rolls-Royce further strengthened in both earnings and balance sheet terms.
For the record, Rolls-Royce produced improved substantial cost based financial performance improvements that have been driven particularly from within the Covid impacted civil aero engine sector. Importantly and as a diverse engineering group, Rolls-Royce Defence and Power Systems divisions enjoyed a strong year of growth.
In the statement to investors Rolls-Royce confirmed that FY21 operating profits were £414m and that pre-tax losses narrowed sharply to £294 million from a previous year £2.80 billion loss. Annual revenue was £11.22 billion, down 2.3% from the £11.49 billion posted the previous year – the decline being due to lower Civil Aerospace sales, while both Defence and Power Systems witnessed growth.
Free cash flow had substantially improved and was ahead of expectations and that previously announced disposals were also on track with the final one expected to complete during the first half of the current year.
In the end year statement Warren East said that:
“We have improved our financial and operational performance, continued to deliver on our commitments and created a better-balanced business capable of sustainable growth. We have achieved the benefits of our restructuring programme a year ahead of schedule, positioning Civil Aerospace to capitalise on increasing international travel. In Defence, we have seen growth driven by strong demand in all our markets and in Power Systems we achieved record order intake in the last quarter. The positive momentum we are generating gives us confidence both in our expectations for 2022 and our future growth. We have also made significant progress with our new businesses in electrical power and small modular reactors, both of which have the potential to create very significant long-term value. We are continuing to make disciplined investments to develop new and existing technologies, which will enable us to seize the significant commercial opportunity presented by the global energy transition driving sustainable returns.”
The company also said that in 2021 it had powered 7.4 million large engine flying hours, up 11% on 2020 with gradual recovery being seen in international flying activity albeit that many Covid-19 travel restrictions remained.
In respect of forward outlook, Rolls-Royce said that “We expect low-to-mid-single digit revenue growth, and we expect our operating profit margin to be broadly unchanged as underlying operational improvement is balanced with increased engineering spend to develop sustainable growth opportunities” and importantly that “we expect to generate modestly positive free cash flow in 2022, seasonally weighted towards the second half of the year.”
Rolls-Royce has also been focussing much attention of developing low carbon solutions as being a key strength and part of an exciting future. Defence has achieved some notable and extremely important orders over the past year including the re-engining of the B-52 for the US Air Force and further orders for the EJ200 partnership engine that powers Eurofighter Typhoon. In Power Systems the company is also leading the development of mini-nuclear reactors to produce electricity and specifically in the civil aerospace industry, investing in potential hydrogen and electric solutions for low carbon flight.
In respect of divisional comment accompanying results Rolls-Royce told investors that:
Civil Aerospace – Our fundamental restructuring programme has been largely completed resulting in higher productivity and sustainably lower costs, better suited to the current environment and positioned well for future growth. The launch of the Airbus A350 freighter in 2021 represents a significant opportunity for our Trent XWB engine, with 58 engine orders secured for the A350F since its launch. In Business Aviation, we achieved two key new selections with our Pearl 10X chosen by Dassault for the Falcon 10X and our Pearl 700 chosen by Gulfstream for the G800. In 2021, we powered 7.4m large engine flying hours, up 11% on 2020 with gradual recovery in international flying activity, which continued to be impacted by COVID-19 travel restrictions.
Defence – Our longstanding commitment to strategic investments in Defence products and facilities has resulted in a strong order book and is driving longer-term sustainable growth. In 2021, we secured new work for the coming decades in the US with the award of the B-52 engine replacement contract, and we remain in a competitive process for the Future Long-Range Assault Aircraft (FLRAA) programme. Our profitability and strong cash conversion are supporting increased investment to meet the customer demand for products that deliver advances in technology and sustainability.
Power Systems – End market demand increased significantly for our Power Systems business in the second half of 2021 as the impacts of COVID-19 reduced. Order intake accelerated, with record order intake in the fourth quarter, driving book to bill of 1.2x in 2021 and good order cover for 2022. Significant awards included a power solution for a hyperscale data centre customer and a first-of-a-kind net zero microgrid which will combine fuel cells and hydrogen combustion engines for the Port of Duisburg in Germany.
New Markets – We have created a new reporting segment for our early-stage businesses with high growth potential, focused on addressing new market opportunities being created by the transition to net zero. Rolls-Royce SMR reached a major milestone with grant funding and new equity investors supporting entry into the UK’s Generic Design Assessment (GDA) process. Rolls-Royce Electrical achieved key product advances with a world speed record for our all-electric aircraft. We believe our two New Markets businesses could generate more than £5bn combined annual revenue by the early 2030s.
In respect of Restructuring, Balance Sheet and Liquidity the company told investors that:
“We have met our £1.3bn run-rate savings target a year ahead of schedule and delivered on our Group restructuring commitment with the removal of more than 9,000 roles from continuing operations. Our focus now is on ensuring the benefits are sustained. Our restructuring programme has fundamentally changed the way we work in our Civil Aerospace business, reducing the size of the business by around a third and creating a more productive, more efficient business poised for future growth.
We are committed to rebuilding our balance sheet. We have announced four disposals which are expected to generate around £2bn in proceeds (including retained cash). Three of the disposals have completed, two in 2021 and the other one since the start of 2022. The final and largest of the disposals, ITP Aero, is progressing well and we expect completion in the first half of 2022. Disposal proceeds, together with underlying free cash flow generation from the Group, will be used to reduce net debt, in line with our ambition to return to an investment grade credit profile in the medium term.
Our liquidity position is strong with £7.1bn of liquidity including £2.6bn in cash at the end of the year after repaying the 2021 €750m bond and the £300m Covid Corporate Financing Facility (CCFF) commercial paper. Net debt was £ (5.2) bn including leases (2020: £ (3.6) bn). Net debt excluding leases was £ (3.4) bn (2020: £ (1.5) bn).
Some of our loan facilities place restrictions and conditions on payments to shareholders. The restrictions mean no shareholder payment will be made for 2021. From 2023, the Board may recommend shareholder payments, subject to satisfaction of the conditions and our consideration of progress made to strengthen the balance sheet. We aim to be able to recommend shareholder payments in the medium term”.
And in respect of Outlook and Financial Guidance:
“We are well positioned for the anticipated growth in our end markets as the impact of the COVID-19 pandemic eases. This, along with continued good contribution from Defence, gives us confidence that we will see positive momentum in our financial performance in 2022 despite the challenges and risks around the pace of market recovery, global supply chain disruption and rising inflation”.
In respect of the decision by Warrant east to stand down at the end of the year Anita Frew, Chair of Rolls-Royce said:
“Warren is an exceptional leader and has set a pioneering vision and strategic direction for Rolls-Royce to lead the transition to net zero across our markets. He has shown incredible tenacity, steering the Group through unprecedented times, and driven substantial cultural change throughout the organisation. He has a real passion for the business which engenders pride in our people and confidence among our stakeholders. He has led Rolls-Royce to a point where we have substantially delivered on our recent commitments to investors and are now firmly set on the path to a more prosperous and sustainable future. We are now running an open and transparent process to find his successor and ensure a smooth transition. I know that during this time, Warren will continue to lead Rolls-Royce with all the dedication he has shown throughout his tenure.”
Warren East, CEO, said:
“It is a privilege to lead Rolls-Royce – it’s a job which I thoroughly enjoy. There have been challenges, but we have built on the cultural and organisational improvements we have made to work through them, deliver on our commitments and create a better business. We have simplified the Group, fundamentally improved our underlying operations and driven long-term change. Rolls-Royce is a dramatically different business today: a leading industrial technology company that is not only addressing the energy transition but embracing the opportunity it presents to generate substantial business growth, including through the creation and nurturing of new businesses with very significant potential. With the advances we have made, the momentum and energy we have shown and our firmer financial foundations, this is the right moment to look to the future. I am thoroughly committed to leading this business while we work towards a smooth leadership transition. The passion and skills of our people, the strength of our technologies and the depth of our relationships, give Rolls-Royce tremendous opportunities to pioneer the vital solutions our planet needs to create a net zero carbon future. This is the biggest technological shift for the Group since the arrival of the jet engine.”
I for one second that. FY22 will be another interesting year for Rolls-Royce and I hope that investors will quickly begin to see the merits of a company that is back on an upward track and that has enormous potential not only to fully demonstrate over time the full benefits of what Warren East and his team have achieved but also to do what it does best – lead in all the areas of technology in the markets that the company serves and reward investors with good returns in the years ahead.
CHW (London 24th February 2022)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785
Skype: chwheeldon
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