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Rolls-Royce - dividend suspended but liquidity boosted

Sophie Lund-Yates, Equity Analyst | 6 April 2020 | A A A
Rolls-Royce - dividend suspended but liquidity boosted

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Rolls Royce Holdings Plc Ordinary 20p

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Rolls Royce has decided not to pay the final 2019 dividend of 7.1p per share, in light of the uncertain economic environment caused by COVID-19.

So far the main impact from the outbreak has been on engine flying hours in the Civil Aerospace business. The disruption means Rolls is undertaking a number of actions to reduce expenditure and boost cash flow by at least £750m in 2020. It has also drawn on its available credit and now has overall liquidity of £6.7bn.

Financial guidance for the year has been withdrawn.

The shares rose 8.9% following the announcement.

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Our view

Coronavirus is a major spanner in the works for Rolls Royce. The group's largest division, Civil Aerospace, is bearing the brunt of the disruption.

This area produces and services aircraft engines, increasingly for bigger widebody planes (think planes with two aisles). Rolls' servicing model charges a fixed amount on a per-flying-hour basis, so having large swathes of global plane fleets stuck on the ground has an immediate impact on revenues. And this is a trend the group expects to get worse before it gets better.

There's also the question of production. Rolls Royce expects a decline in the number of engines it will deliver, which isn't surprising given the strife faced by airlines at the moment. The sum total of the damage will depend on how long the disruption lasts, and the toll it takes on Rolls' key customers and supply chains.

The inevitable knock to profits and cashflow isn't the best news. Cash flow has been a thorn in the group's side before, but Rolls had been making good headway in smoothing things out. The target of achieving at least £1bn in free cash flow this year has probably been put on the scrapheap.

A final problem is the lingering Trent 1000 engine fiasco. Progress is being made, but the final hurdle won't be cleared until 2021, and that deadline's been extended more than once. In all it's been a very expensive foul up, both financially and for the group's reputation.

However, in our view Rolls Royce still has some real positives.

The first, and perhaps most important in the current climate, is substantial liquidity. It would take a pretty major turn for the worse for the group to run out of financial headroom. Although of course if the shutdown goes on longer than anticipated even the biggest resource pile could come under strain.

The other thing Rolls has in its favour is a multi-billion pound order book, which is being boosted by defence contracts. That gives the group excellent visibility over a significant chunk of revenues compared to less defensive businesses. Defence spending should remain robust, but if the outbreak causes a severe economic shock, a drastic scenario could see governments decide to rein in spending. In all though, being the go to "critical" defence supplier for the UK and US governments is a great position in our view.

Rolls continues to be a sum of very different and complex moving parts and the coronavirus outbreak poses inevitable challenges. We think the long-term attractions of the business are still intact, and the group's financial position means it should weather the storm. But we can't rule out ups and downs from here - the extent of the damage rests squarely on how long and how deep the virus cuts the economy and Rolls' key customers.

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COVID-19 trading update

In Civil Aerospace Widebody flying hours fell around 25% in the first quarter, and about 50% in March. That comes as airlines have grounded more planes in recent weeks, and Rolls Royce expects flying hours to fall further in April.

Engine output was broadly stable in the first quarter as airframe customers maintained production levels. However, these customers are facing challenges because of the outbreak so the group expects a decline in engine deliveries, as well as Maintenance, Repair and Overhaul (MRO) volumes.

Actions to reduce aircraft on the ground in the wake of issues with Trent 1000 engines have made progress. These are down to the mid-20s, compared with mid-30s at the end of February. This is expected to reduce to single digits by the end of the second quarter, and the new blade design should be ready to be added to the fleet by the end of the first half of 2021.

Reduced economic activity is expected to affect full year performance in Power Systems, although the division delivered a "relatively resilient" first quarter.

Within Defence, there has been no material disruption from the outbreak. UK and US governments have chosen Rolls Royce as their critical supplier, and the group's Defence facilities remain open.

Actions to preserve cash include lowering discretionary spending, including non-critical capital expenditure projects, stopping non-essential travel, freezing external recruitment, and reducing workforce salary costs by at least 10%. Senior management and the Executive Team will have salary costs reduced by 20%.

Rolls is part of the VentilatorChallengeUK Consortium, which is working to increase the UK's supply of ventilators.

The group has introduced new measures to ensure it's in-keeping with social distancing measures, including working from home where possible and modified shift patterns.

Due the possibility of a "prolonged reduction in trading activity" Rolls Royce drew down its £2.5bn revolving credit facility, and now has a gross cash balance of £5.2bn. It's also secured a £1.5bn revolving credit facility. None of the group's borrowing is subject to conditions set by its lenders, known as covenants. It's also not dependent on the group's credit rating.

There is one outstanding debt maturity this year - a $500m bond which is due for repayment in the second half of the year.

The reduction in liquidity for the first quarter mostly reflects the usual movements in seasonal working capital at this time of year, and was in line with guidance. Before actions to offset the impact, COVID-19 provided a headwind of £300m.

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