What a year, what a time and what a fantastic job of work that Rolls-Royce senior management has achieved over the past year as it faced up to an unexpected situation and one that would require unprecedented levels of action if the company was to be able to secure its long-term future.
The result? A resized, reshaped, refinanced and reinvigorated company, one that is now in my view not only through the worst of the C-19 impact on its business but also one that is now genuinely, very well placed for recovery.
The FY2020 results presented by Rolls-Royce to the investment community this morning may well be the worst in the history of this hugely important UK based aerospace, defence and energy systems engineering company but, through the fast and well-considered actions taken by senior management in order to mitigate the C-19 pandemic situation through last year, it is also an occasion where they have also been able to say that the company is now very well placed both operationally and financially for future recovery.
What management have done, what they have achieved, how they have through the actions they have taken not only to refinance the company including a £2bn rights issue, the raising of £5.3bn lines of new credit through bonds, bank loans and commercial paper in order to ensure the company has more than sufficient future liquidity is a remarkable achievement in itself but what they have also done in providing reassurance and future confidence for the future is hugely important.
With £9bn of liquidity available at year end suffice to say that even if a recovery in the air travel industry takes longer than many currently anticipate, Rolls-Royce is well placed in respect of having more than sufficient liquidity in order to carry it through an extended period.
Availability of liquidity in a business such as this cannot be underestimated and through the course of the past year Rolls-Royce has not only placed itself in a position where it has more than sufficient levels of available liquidity to face expectations that revenues will not be back to 2019 levels until 2022 but also that, should a plausible further downside position in the aviation industry occur, that is has sufficient funding for operations, business development and near term debt maturities.
As important as ensuring future liquidity requirement has been the huge effort to reduce the cost base whilst at the same time ensuring that the company could maintain a sufficient level of skills required for the ultimate recovery. The restructuring programme announced last May will see a reduction of at least 9,000 positions by the end of 2022 – most of these being job eliminations within civil aerospace. The company says that by the end of the 2020 7,000 permanent and contractor roles had been removed through a combination of redundancy, voluntary severance and natural attrition. These actions together with reduction in capital spend and which come on top of the long running programme that CEO Warren East launched in 2016, will see operating costs reduced by a further £1.3bn verses 2019 levels realised by the end of FY2022.
As important as realisation that Rolls-Royce has now placed itself in a strong financial position in respect of liquidity requirements and that, as a result of the significant actions taken, the company is well placed for future recovery in civil aerospace when that comes, is also that the company isn’t just about civil aerospace propulsion systems. The diverse nature of operations that quite apart from the major element of civil aerospace includes defence, nuclear and power systems are hugely important elements of the business in respect of assessing the future outlook and performance. Defence in particular has done well through FY2020 and with a strong order book, good visibility through the current year and an installed base of 16,000 engines the outlook is good. Similarly, power system can look to benefit from the continuing shift towards more sustainable, lower carbon power solutions most notable of which are hybrid-electric and hydrogen solutions as well as microgrids.
In respect of the pace and timing of recovery in the civil aerospace sector, having reset the cost base in order to deliver improved returns and greater operational efficiency the company anticipates that large engine LTSA flying hours (EFH) in 2021 are expected to increase to around 55% of 2019 levels (2020: 43%) with an acceleration in the second half as global vaccination programmes enable travel restrictions to be lifted. In 2022, the company has set a base case expectation for EFH to reach around 80% of 2019 levels (previously 90%). Large engine deliveries are expected to remain at the current lower levels for the next few years.
Not surprisingly, while near term uncertainty in relation to the speed of recovery in respect of civil aerospace remains highly sensitive to developments and government actions globally in respect of C-19, the company has provided a range of expectations in respect of free cash flow (FCF) and engine flying hours (EFH). In respect of FCF the company anticipate this to be in the region of a £2bn outflow in 2021 and in respect of EFH for this to be around 55% of 2019 levels. FCF outflow is weighted towards the first half of the year before turning positive at some point during the second half of the year.
In addition, Rolls-Royce has said today the company that it believes FCF of at least £750m (excluding disposals) is achievable when EFH exceed 80%, on average, of 2019 levels for a 12-month period and for which target, underpinned by cost reductions and management actions, the company is aiming to reach as early as 2022. Exact timing will of course be dependent on the pace of air travel recovery.
In the medium term the company aims to return to a net cash position and an investment grade credit position driven by free cash generation and the planned £2bn disposal programme.
That the results figures presented by the company for FY2020 and that included a near £4bn underlying loss and free cash outflow of £4.2bn make horrible reading can hardly be denied. Last year was an unprecedented but of far more importance is what the company has achieved in such a very short time in order to mitigate the impact that the C-19 pandemic has had on group performance whilst at the same time building on its strengths and readying itself for recovery whenever that comes.
CEO Warren East said in the results statement that:
2020 was an unprecedented year and I would like to thank everyone at Rolls-Royce for their hard work, dedication and sacrifice to help secure the Group’s future. The impact of the COVID-19 pandemic on the Group was felt most acutely by our Civil Aerospace business. In response, we took immediate actions to address our cost base, launching the largest restructuring in our recent history, consolidating our global manufacturing footprint and delivering significant cost reduction measures. We have taken decisive actions to enhance our financial resilience and permanently improve our operational efficiency, resulting in a regrettable, but unfortunately very necessary, reduction in the size of our workforce. With the support of our stakeholders we successfully secured additional liquidity with a rights issue, bond issuance and further credit facilities put in place during the year. We have made a good start on our programme of disposals and will continue with this in 2021. We continue to invest in developing market-leading technology and low carbon opportunities in all our end markets, to create value for our stakeholders and ensure we are well positioned to take advantage of the transition to a lower carbon economy and growing demand for more sustainable power solutions.”
Given uncertainty of when recovery in the aviation sector will begin makes forecasting the art of the impossible but what is certain is that through the hard work and actions taken by CEO Warren East and outgoing Finance Director Stephen Daintith, Rolls-Royce is from both an operational and financial position very well placed to move forward from here on with far greater confidence.
Neither should it be ignored that despite all the considerable effort to reduce costs, make itself more competitive and into a position where it has more than sufficient liquidity to move forward that Rolls-Royce has also continued to invest in its own future by developing market-leading technology and low carbon opportunities in all of its end markets in order not only to create value for its stakeholders but importantly, to ensure that the company is very well positioned to take advantage of the transition to a lower carbon economy and growing demand for more sustainable power solutions.
CHW (London – 11th March 2021)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785