No profit warning, no shocks and despite not everything going its way, Rolls-Royce FY17 results demonstrate a range of remarkable performance improvements. This is only the start in my view and there is clearly a lot more hard work and benefit to come. FY17 results have been about delivering on the promise and expectation of financial improvement and for that they are to be seen from where I sit as being the ingredients necessary for future confidence.
Rolls-Royce had promised that 2017 would be a year of progress and delivery of performance enhancement and despite more work to be done FY17 results this morning demonstrate that the company has achieved what it set out to do. That is not to suggest that Rolls-Royce is anywhere near completing the significant restructuring and realignment process that it set out to achieve in late 2025 but with FY17 results demonstrating strong underlying performance, sound financial management and that includes improved free cash flow and the benefit of having already achieved £200 million of annual cost savings from the original 2015 transformation programme so far, I am in no doubt that Rolls-Royce is now well on the way to positioning itself for a very sound and exciting future.
FY17 results were ahead of internal expectation. Underlying revenue, profits before tax and earnings per share rose by 6%, 25% and 27% respectively and importantly, improvements in operating and profit performance provided additional financial benefits as well such as a significant improvement in free cash flow.
The latter free-cash-flow improvement is despite the £170 million cash cost for Trent 1000 and Trent 900 extended life turbine blade modification taken in FY17 and which is expected to peak during in FY18. Net Debt at year end was £529 million and the order backlog at the end of 2017 was £78,476 million.
The year has not been without some disappointments and Marine activities have continued to disappoint. Rolls-Royce has already announced that it is currently evaluating options for its Marine business activities although I am in little doubt that it remains very committed its defence maritime activities. More detail on the future of marine activities can be expected later in the year.
The other disappointment has been the issue of lower than expected durability of a small number of parts in Trent 1000 engines for which not only has a solution been found but also in my view, the company has through this been able to achieve a better understanding of the technical and operational issues involved in managing in-service engine issues. Trent 1000 accounts for 11% of the in-service Rolls-Royce widebody engine fleet.
In January Rolls-Royce announced a change in divisional structure and that would be based on three tightly focussed divisional operating units – Civil Aerospace, Defence and Power Systems. The company believe that changing the divisional structure will create the ability to act with greater pace, to innovate in core technologies and to better take advantage of future opportunities such as electrification and digitalisation, both of which are key pillars of future strategy. Rolls-Royce said in its statement today that divisional restructuring will then focus on management, support and engineering and technology functions across the corporate centre and within the three divisions with the aim of driving simplicity, agility and pace into the business.
The outlook statement shows that Rolls-Royce is anticipating further revenue and operating profit improvements in 2018 together with a further significant rise in free cash flow. Capital expenditure is anticipated to remain similar to last year at around £775 million in 2018 and net research and development around £50 million higher than last years at £1,035 million.
Free-cash-flow expectations are extremely important to the company but also in respect of how the investment community judge performance improvement. Here it is worth reminding that Rolls-Royce has set its ambition at delivering £1 billion of long term sustainable free cash flow by around 2020 and for this to further improve beyond that. In respect of forward expectations and further beneficial change, I can of course do no better than repeat what CEO Warren East said in the results statement this morning:
“As I look to the year ahead, we are embarking on a more fundamental restructuring programme with a refreshed leadership team and an improved market environment. The new business structure provides us with a clearer focus on our customers and markets and, combined with our growing installed base, particularly of widebody engines, delivers the potential to drive sustainable long term free cash flow towards our mid-term ambition of around £1bn by around 2020 with further growth over the subsequent years.
2018 will be one of significant operational progress. In Civil Aerospace we will continue to grow our installed widebody fleet and further reduce cash deficits on engine sales. At the same time over the next few years we will be continuing to implement solutions for our airline customers to address the in-service engine issues we are currently experiencing, the estimated costs of which are significant but are included in our cash flow, revenue and earnings guidance for 2018 and beyond. While Defence faces some challenges due to timing changes on export activity and in contract mix, we continue to have attractive longer term export opportunities. After a year of strong recovery, Power Systems is well positioned for another year of good progress, all of which bodes well for the year ahead.”
Rolls-Royce has achieved much else besides improved financial performance in FY17. For instance, the company achieved a number of important operational and technological milestones including the first flight of three new engine designs – the Trent 1000 TEN, Trent XWB-97 and Trent 7000 – within a 12 month period. The year also witnessed the first successfully run high power tests of the power gearbox that sits at the heart of the new UltraFan large engine design.
In Defence the company was able to renew a number of core US contracts and further developed its service delivery capability. Power Systems which has also been moving through a process of portfolio rationalisation and cost reduction effort has seen some strengthening in key markets such as mining, agriculture and construction.
I have made no comment here in respect that 2018 will see reporting of underlying results produced under the IFRS 15 basis of accounting method. Clearly, this will have a significant impact on future P&L reporting.
A quick summary comment here relating to divisional performance last year – as stated by the company and on the old five division structure basis ahead of the restructuring to three divisions which took effect on January 1st 2018:
Civil aerospace produced revenue of £8,023 million and underlying profit of £520 million, up 12% and 34% respectively driven by a 35% increase in large engine delivery volumes and a 12% increase in invoiced flying hours. Defence underlying revenue was £2,275 million and operating profit £374 million whilst Power Systems produced revenue of £2,923 million and operating profit of £330 million. Marine produced underlying revenue of £1,077 million and an operating loss of £25 million whilst Nuclear produced underlying revenue of £818 million and underlying operating profit of £38 million.
CEO Warren East has considerably strengthened management through the year. Stephen Daintith was appointed as Chief Financial Officer, Paul Stein as Chief Technology Officer and Simon Kirby joined the company early last year as the Chief Operating Officer. Chris Cholerton is now President – Civil Aerospace and Tom Bell will soon be returning to Rolls-Royce as President – Defence. Harry Holt is now Group HR Director.
A year that has evidence great progress and one in which the company has not only demonstrated excellent performance improvement combined with sound strategy and excellent communication, but one in which confidence has been restored. Delivery is everything and not withstanding disappointments and more work that needs to be done, CEO Warrant East is delivering on the promise. The future for Rolls-Royce looks excellent.
CHW (London – 7th March 2018)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785