A return to profitability, strong liquidity, restructuring expected to achieve £1bn costs savings in the current year together with anticipation of a huge full year improvement in free cash flow are the main highlights of what are a significantly improved set of first half results from Rolls-Royce.
Underlying operating profit of £307 million against a 2020 H1 (£2,862 million loss) show the extent of change that has occurred over the past year. The result of the massive restructuring that has taken place over the past year is that Rolls-Royce cost base has been cut by one third, that efficiency is markedly improved and the massive cash outflow that occurred in 2020 has now been dramatically reduced.
None of this says that the work to position Rolls-Royce where senior management wishes it to be is complete. That said, interim results provide ample evidence that this hugely important company has now come through the worst of what can only be described as unprecedented and unexpected impacts from C-19 that have for the past eighteen months devastated the commercial aviation industry.
The interim results also confirm that the company has, both by the actions taken to make itself leaner, fitter and more competitive combined with the strong liquidity position now established, positioned itself well for recovery as international slowly but surely travel rebounds along with the ability to better withstand future uncertainties.
Faced with the position they had been in March last year, Rolls-Royce senior management team are to be commended for their incredible effort and for leaving no stone unturned in order not only to place the company onto a sound footing operationally but also in order to establish the strong £9 billion liquidity position that they have and that will allow the company to move forward through the recovery stage and back into growth.
Be in no doubt that it was no mean feat securing the strong liquidity position that the company has now established and it is worth recalling that during a period of less than six months Rolls-Royce senior management team achieved this through the strength of established relationships that the company has with its banks and with the wider investment and financial market community. Relationships can only be based on integrity, honesty and trust combined with good communication – all crucial requirements that Rolls-Royce management has proved that it has in spades.
The company said in the accompanying detailed statement that “Our liquidity position is strong with £7.5bn of liquidity including £3.0bn in cash at the end of the half year after repaying the 2021 €750m loan notes and the £300m Covid Corporate Financing Facility (CCFF) loan in the first half. Net debt (before leases) was £ (3.1) billion at the period end” and that “this week the Group signed an extension to the 2022 £1bn unused loan facility to 2024, consequently the Group has no debt maturities before 2024 (excluding ITP Aero). Free cash outflow of £ (1.2) billion represented a significant improvement on the prior year period of £ (2.9) bn which included a £ (1.1) bn negative impact from the cessation of invoice factoring”.
No dividend payments will be made 2023 and the company re-affirmed that “Our priorities for capital allocation are to rebuild the balance sheet and to invest in the business to grow returns ahead of returning surplus cash to shareholders. We are focused on generating appropriate value on our disposals and improving free cash flow. This will reduce net debt and take us towards our ambition to return to an investment grade credit profile in the medium term.
In respect or outlook and financial guidance the company said that “We continue to expect to turn free cash flow positive sometime during the second half of this year and to achieve an improvement in full year free cash outflow to around £ (2.0) bn (FY2020: £ (4.2) bn). This is driven by our actions to reduce costs, continued strength in Defence, growth in Power Systems and a gradual recovery in Civil Aerospace. Our guidance remains sensitive to the timing of OE concession outflows on already delivered widebody engines, as we previously highlighted in our full year results in March”.
The £2 billion target plan for disposals is making good progress and the sale of one subsidiary company – Bergen Engines in Norway to UK based Langley Engineering was announced yesterday. ITP is included in the results as discontinued activities and disposal of this is widely expected to occur shortly.
In respect of divisional breakdown, Civil Aerospace operational performance was in line with expectations. Large engine LTSA flying hours were 43% of the 2019 level, a 9-percentage point improvement from second half 2020. Domestic large engine flying hours exceeded 2019 levels in May and made up approximately 20% of the large engine activity in the period. Business aviation flying recovered to 2019 levels by the end of the first half. Engine deliveries were down from the prior period, reflecting the build schedules of widebody airframer customers and the transition between engine programmes for business aviation.
In respect of Civil Aerospace outlook, the company said that while the “timing of civil aviation recovery, particularly for international travel, remains uncertain and sensitive to the developments of the COVID-19 virus. For 2021, we expect the recovery in business aviation and domestic flying to be sustained and a continuation of the gradual improvement in international flying, which is constrained by the border restrictions in place worldwide. We are encouraged by forward indicators, including vaccination programmes and expect the recovery to accelerate once restrictions are lifted”.
Power Systems witnessed increased activity levels and order intake was 19% higher than the previous period. Underlying revenue was broadly unchanged although operating profit was marginally higher as were margins. Aftermarket revenue increased with year on year growth strongest in marine, governmental and power generation. The company expects to see an improvement on original equipment beginning during the second half period.
The Defence business continued to perform well with resilient demand for OE (Original Equipment) and services. First half growth was helped by the earlier timing of spare engine and spare parts sales, which typically have been in the second half in prior years. The favourable timing and mix in the first half is expected to result in a stronger first half versus second half performance, and our full year expectations for Defence are unchanged. Order intake during the period was £1.2 billion.
Rolls-Royce Interim results provide very reassuring reading and while there will clearly be residual impacts from C-19 that will impact on the whole of the civil aerospace and aviation markets for some while yet, the results demonstrate real progress.
CEO Warren East, Chief Executive said in the statement:
“Our continued focus on the elements within our control, together with a good performance from Defence and order intake recovery in Power Systems have enabled us to deliver solid progress in the first half. The benefits of our fundamental restructuring programme in Civil Aerospace are evident in our reduced cash outflow and improved operational efficiency. This leaner cost base together with a strong liquidity position gives us confidence in our ability to withstand uncertainties around the pace of recovery in international travel and benefit from the eventual rebound. We are making disciplined investments in the new opportunities to drive future growth, particularly in net zero power where we are leading the way with innovation and engineering excellence. Our net zero pathway and targets, announced in June, set out our plan to enable the sectors in which we operate achieve net zero by 2050 by driving step-change improvements in engine efficiency, helping accelerate the take-up of sustainable fuels and developing new technologies. “
The past eighteen-month period has been one that few could have envisaged but through hard work and a determination to succeed Rolls-Royce has come out on the other side leaner, fitter, more competitive and readying itself for a return to growth. It is of course very regrettable that the company has been forced to shed so many staff but equally it was right that management acted as quickly as they did to establish a revised based from which Rolls-Royce could recover and grow situation. There is no complacency within Rolls-Royce and there is still much work to be done to adapt to the many changes that have been required.
The future contains many still contain uncertainties and risk but equally, it also contains a raft of varied opportunities. Having been consistent throughout in its messaging and by investing in its own future in order to stay at the forefront of technology, I believe that Rolls-Royce is now very well placed for a very interesting and positive future.
CHW (London – 5th August 2021)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785