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Rolls-Royce - full year profits to be at low end of guidance

Nicholas Hyett | 7 November 2019 | A A A
Rolls-Royce - full year profits to be at low end of guidance

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Rolls Royce Holdings Plc Ordinary 20p

Sell: 724.20 | Buy: 724.60 | Change 7.40 (1.03%)
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Rolls-Royce now expects full year operating profit and free cash flow to be at the lower end of guidance, reflecting extra costs associated with the Trent 1000 engine problems.

Operating profit is expected to be negatively impacted by around £1.4bn.

The shares were little moved following the announcement.

View the latest Rolls-Royce share price and how to deal

Our view

We like Warren East's strategy to simplify and streamline Rolls-Royce.

By focusing on cash flow rather than accounting profit, he's using a sensible and shareholder friendly metric to measure success. In recent years you could have flown a plane between Rolls' cash flows and profits, such has been the difference.

These days the business is focused around three core areas.

The largest of these, Civil Aerospace, is currently loss-making and lagging behind international competitors. But there's potential for a recovery. Business and leisure travel should rise going forwards, and Rolls is a leading supplier of the engines for long-haul, wide body planes.

Recent developments are encouraging. Losses from original equipment are narrowing, the all-important aftermarket revenues are growing and the next generation of engines are coming through. Defence and Power Systems are also delivering improvements, with order books building.

That might be good news, but issues with the Trent 1000 model rumble on. The final hurdle won't be cleared until 2021 now, and that deadline's been extended more than once. Keeping customer's planes flying until the problem is fixed is costing the group money, and it feels like Rolls has simply dropped the ball on this one.

Still, the ball is very-much in-hand in the cash flow department. Despite the extra costs associated with the Trent 1000 fiasco Rolls is confident it can lop £400m off the cost base within the next couple of years and deliver free cash flow of at least £1bn in 2020. The prospective yield is a fairly grounded 1.9% this year. But if Rolls can make good on its plans, a few dividend increases could follow.

Of course, this can't be guaranteed. Predicting the future is difficult, especially in such a complex business. There's scope for the aftermarket business to be stifled by a quicker than expected engine retirements, while weaker economic growth, or a trend towards narrowbody craft would also hurt. Neither can be ruled out.

Overall Rolls Royce is a sum of many, very different, moving parts. The huge scale of its projects means there's always the chance everything won't go exactly right, and it won't always be a smooth ride. But not many companies can talk about generating a billion pounds worth of free cash, and at the end of the day, while jumbo jets still need new engines, Rolls will keep selling and servicing them.

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Third quarter trading update

A key blade component of the Trent 1000 engine has been delayed until 2021. The effect on operating profits reflects extra costs to minimise customer disruption, including boosting maintenance capacity, and the loss of some contracts.

Within the rest of Civil Aerospace, the "vast majority" of the installed fleet is performing well, with continued growth in widebody engine flying hours. The Trent XWB engine, which is about 15% of the fleet, is exceeding expectations. The Trent 700, which is around a third of the installed fleet, is also delivering very strong performance.

Power Systems now expects full year revenue growth to be in the low to mid-single digit percentage rage, driven by some delivery deferrals on large projects. Previous guidance was for mid-single-digit revenue growth.

The Defence business continues to foresee steady sales and modest margin decline for the full year.

Rolls Royce expects to deliver FCF of at least £1bn in 2020. Longer term, it's confident it can maintain its medium-term target of at least £1 of FCF per share.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.