Rolls Royce now thinks it can deliver up to £1.0bn of cash savings this year, compared to a target of £750m. The savings are in response to the disruption being caused by coronavirus.
The group believes the commercial aerospace market will take several years to recover from the outbreak. As a result Rolls is looking at ways it can restructure the business, particularly in the important Civil Aerospace division. These changes are likely to result in a number of redundancies. The group's in talks with trade unions, and said it's looking to "establish a more appropriate cost base in order to secure our future for all stakeholders".
4,000 employees are currently furloughed.
The shares fell 4.8% following the announcement.
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, profits, and crucially - cash flow. And this is a trend the group expects to get worse before it gets better.
There's also the question of production. Rolls' main customers are not only not servicing engines, but few are ordering new ones. That means the group won't be delivering as many engines as planned, which reduces revenues and profits further. The extent of the damage here will depend squarely on when planes start flying again, and when airlines feel confident enough to splash the cash on new jet engines. British Airways owner IAG doesn't think the commercial aviation sector will resemble "normal" until 2023, so we expect that slowdown to feed into Rolls' performance for some time yet.
The inevitable knock to profits and cashflow isn't the best news. Cash flow has been a thorn in the group's side before, and the target of achieving at least £1bn in free cash flow this year has been put on the scrapheap and instead replaced with news cash flow will be firmly negative. As and when things do start to get back to normal, this grisly situation should start to improve.
And, 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, and being a go to "critical" defence supplier for the UK and US governments is a great position in our view.
The coronavirus outbreak poses inevitable challenges. We expect Rolls to make it through the disruption, and its long-run attractions remain intact. But Rolls is a classic example of "take a long term view", so investors should be prepared for a bumpy ride in the near to medium term. The extent and duration of the disruption to Rolls depends how long conditions last, and how well its key customers and supply chains can re-find their feet.
Trading and market update
In Civil Aerospace widebody engine flying hours (EFH) were approximately 40% lower than previous expectations in the first four months of the year. And the grounding of aeroplanes around the world means there was a 90% drop in EFH in April.
The reduced activity means Rolls is performing lower volumes of engine maintenance and servicing, and full year levels will be lower than 2019. The group's airframe customers have cut production output, meaning 250 widebody engines will be delivered in 2020, down from previous guidance of 450.
In Power Systems weaker trading has been driven by lockdowns and travel bans, the effect of which has not been offset by cost saving efforts. As a result, the division's "performance in 2020 is likely to show a material deterioration compared to the prior year". The pandemic has been a particular headwind for Rolls' industrial end markets, including oil & gas and mining, and a reduction in Yacht production.
Within Defence, there has been no material disruption from the outbreak. But the impact of social distancing and self-isolation on operations and suppliers represents a potential risk to activity levels.
The group anticipates a significant net cash outflow in the second quarter.
It has increased its new revolving credit facility to £1.9bn, from £1.5bn.
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