With upbeat guidance clearly evident in the Rolls-Royce trading statement this morning as benefits of cost reductions show through, market recovery evidenced in large engine flying hours, improving free cash flow, significant Defence orders won during the year, demand improvements in Power Systems together with disposals totalling around £2bn having been announced combine to demonstrate that Rolls-Royce is not just on the mend but that the company is moving forward apace.
Rolls-Royce CEO Warren East said in the statement that “We are delivering on the elements within our control and are focused on our commitments. We have achieved good results with our fundamental restructuring programme, as we sustainably reduce costs and deliver a leaner and more efficient company and are firmly on course to complete our disposals programme. While external uncertainties clearly remain, we have seen continued gradual recovery in our Civil Aerospace business, a growing order book in Power Systems and have secured a significant contract win in Defence. We are investing in the net zero technologies and solutions that we need across the group to grasp the tremendous commercial opportunity of the global energy transition and drive long-term value. This all underpins our strategy of creating a better quality and more balanced business which can deliver significantly improved returns and cash flow into the future.”
While there has been some improvement in numbers of flying hours of Rolls-Royce powered large aircraft there is clearly still a very long way to go, despite news of a new C-19 variant the company continues to predict flying hours moving in a positive direction. Rolls-Royce engined wide-bodied aircraft are used by airlines across the globe and while the latest news in the UK in regard of the Omicron variant is unhelpful, such news should be taken in a global context. The company does not anticipate the aviation industry moving backwards and I share that view.
Having announced a turnaround plan designed to produce £1.3bn of annual cost savings the company says that it is already set to deliver £1bn by the end of the current year. The company has now turned cash-flow positive and this should mean that it will beat previous guidance for FY21. The important point though is that Rolls-Royce is ahead of plan in regard of restructuring and while it is sad that in the process it has needed to shed 8,500 staff this year, the fact that it has acted so quickly to secure its future should not be lost. Neither, as financial detail provided in the half year statement in August confirmed, should the fact that the company is well positioned with £7.5bn of liquidity that included £3.0bn in cash at the end of the half year following repayment of €750m loan notes and the £300m Covid Corporate Financing Facility (CCFF) loan. At that point net debt (before leases) was £3.1 billion and subsequent to this the company signed an extension to the 2022 £1bn unused loan facility to 2024, consequently the Group has no debt maturities before 2024 (excluding that of ITP Aero).
I will at this stage make one repeat of what I had said in August following the Interim Results announcement:
‘Faced with the position that the company found itself in March 2020, senior management are to be commended for the incredible effort and for leaving no stone unturned in order not only to place the company onto a sound footing operationally and financially. Having established the strong £9 billion liquidity position, Rolls-Royce can now move forward through the rest of its recovery stage and back into growth. Having secured a strong liquidity position in the last financial year it is also 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, trust and confidence combined with good communication – all crucial requirements that Rolls-Royce management has proved that it has in spades.’
In what is a well detailed trading statement this morning the company confirmed details of several already announced disposals that will, when all are completed by the first half of next year, have raised around £2bn – all of which together with underlying free cash flow generation will be used to reduce debt. The disposals include Civil Nuclear Instrumentation & Control (completed in November with €99m proceeds received plus €37m retained cash) – ITP Aero (this was announced in September with completion expected in H1 2022 – anticipated proceeds of €1.7bn plus retained cash) – Bergen Engines (completion expected before current year end with anticipated proceeds and retained cash totalling around €100m) and finally – the 23.1% holding the company has in AirTanker Holdings, proceeds of which, on completion anticipated in the first quarter of next year, will be £186m.
Current in-line trading in the Defence division with the highlight being the winning of the B-52 replacement engine competition and which I have previously written on. The award to re-engine the US fleet of 76 eight-engine aircraft has a total value of $2.6bn. The initial phase of the contract is for testing and development with a value of around $500m.
In the Power Systems division, the company says that recovery of customer demand in many end markets is now driving improvements in order intake. However, as a business with a shorter cycle and higher inventory turnover than in its Civil Aerospace and Defence businesses, Power Systems does have greater exposure to current global supply chain disruption and that significant near-term supply chain pressure looks set to continue for some time albeit that focused supply chain reporting and procurement practices are helping to mitigate the impact in 2021.
In addition, the company says that Rolls-Royce SMR (Small Modular Reactors) has now moved into a second phase with the foundation of a special purpose vehicle with new investors raising funds totalling £145m in exchange for approximately 20% of the equity, in addition to a £50m commitment from Rolls-Royce, and matched funding from the UK Government of up to £210m, these funds support the UK Generic Design Assessment process for new nuclear power plants and identification of factory sites for the manufacture of the power plant modules.
The above is an important step forward in what the government intends will be a new generation of small modular reactors that will be far quicker and cheaper to roll out than traditional large-scale nuclear reactors such the currently in-build Hinckley Point C project in Somerset and the planned Sizewell C in Suffolk.
Describing SMR’s as “a once in a lifetime opportunity for the UK to deploy more low carbon energy production than ever before” and also to regain energy independence, Business Secretary Kwasi Kwarteng is well aware of the intellectual property and the potential domestic and export benefits that innovative nuclear technologies such as SMR can and will create for the UK. With many decades of experience in development of nuclear submarine propulsion systems and on which small modular reactor technology is based, this is a significant future opportunity for the company. Each SMR is expected to have a generating capacity of 470mw which I am told is enough to power 1.3m homes. Currently around one fifth of UK electricity demand is fuelled by 13 nuclear power plants but with more than half of these due to be decommissioned over the next five years together with a near doubling of the cost of gas and the obvious impact of this on gas powered electricity generation cost, the fact that nuclear powered plants are clean in respect of carbon emissions, I regard the potential long term demand for the SMR technology will be significant.
CHW (London – 9th December 2021)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785