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Rolls-Royce - Trent 1000 costs in line with expectations

Sophie Lund-Yates, Equity Analyst | 28 February 2020 | A A A
Rolls-Royce - Trent 1000 costs in line with expectations

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Rolls Royce Holdings Plc Ordinary 20p

Sell: 86.72 | Buy: 86.78 | Change 0.08 (0.09%)
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Full year underlying operating profit rose 25% to £810m, helped by record widebody engine deliveries. Once costs associated with the Trent 1000 engine are taken into account, reported profit showed a loss of £852m.

However, these exceptional charges were in line with guidance given in November.

The total returned to shareholders was 11.7p in 2019, which was flat compared to the previous year, and the shares rose 4.2% following the announcement.

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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, has returned to profitability after a period of lacklustre performance. That's being helped by increased volumes of Rolls' engines used on bigger, long-haul commercial planes - as well as money made by servicing those engines.

We're also pleased to see Defence and Power Systems 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, and that deadline's been extended more than once. Keeping customer's planes flying until the problem is fixed is costing the group money. Efforts to solve the issue do seem to be back on track, but there's no getting away from the fact 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 deliver free cash flow of at least £1bn in 2020. The prospective yield is a fairly grounded 2.4% 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. The group's also keeping a close eye on coronavirus- some of the major airlines are already reporting disruption and any prolonged changes to travel trends wouldn't be good news. Right now though, it's too soon to call what the overall impact will be.

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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Full year results (underlying figures unless otherwise stated)

Full year revenue rose 6% to £15.3bn excluding the impact of exchange rates, and was broadly in line with expectations.

Despite "tough market conditions" Power Systems revenue rose 4% to £3.5bn. That reflects strong demand for mission critical power generation products, and a 4% increase in servicing revenues. This increase combined with improved margins meant operating profit was up 15% to £357m. Rolls has decided to carry out a strategic review of Bergen, the smaller medium speed gas and diesel engine business.

Civil Aerospace delivered a record 510 widebody engines in 2019.. Revenue rose 10% to £8.1bn, partly driven by a 14% increase in services which accounted for around 59% of revenues. Higher service revenues and spare part sales helped margins improve, and offset a 13% rise in research & development (R&D) spending. As a result operating profits improved £195m to £44m.

Defence revenue increased 1% to £3.3bn, which was held back by delivery timings of transport engines. Operating profit fell 7% to £415m, due to the lower transport volumes, although this was in line with expectations.

The ITP Aero business saw revenue rise 21% to £936m, with higher engine volumes and improved pricing helping profits to increase 67%.

Improved profitability helped core free cash flow increase by £263m to £911m. Excluding new accounting policies which count leases as debt, the group has a net cash position of £1.4bn, compared to £611m.

The group recognised £578m of cash costs relating to the Trent 1000 programme, partly offset by insurance payments. It also recognised a £1.4bn exceptional charge for 2019. Rolls continues "to expect cash costs of £450-£550m in 2020 and a similar level in 2021, before declining significantly thereafter."

Rolls Royce said it remains confident in its medium-term target of at least £1.9bn in free cash flow, and aims to generate £1bn next year.

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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 for more information.

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