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Rolls Royce - continues to soar as profits jump

Rolls Royce's first-half underlying revenue rose from £5.3bn to £7.0bn, powered by increases across Civil Aerospace, Defence and Power Systems.

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Rolls Royce's first-half underlying revenue rose from £5.3bn to £7.0bn, powered by increases across Civil Aerospace, Defence and Power Systems.

Underlying operating profit jumped from £125m to £673m. This was driven by higher revenues and improved profitability in the group's key Civil Aerospace division, where profits were up by £479m.

Free cash flow rose from an outflow of £68m to an inflow of £356m, driven by improved underlying operating profits which is more than offsetting cash outflows as inventories rise. Net debt improved from £3.3bn to £2.8bn.

Recently upgraded full-year guidance has been reiterated. Underlying operating profits are expected to land between £1.2b-£1.4bn, and free cash flow's expected to be in the £0.9-£1.0bn range.

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

Our view

Rolls Royce produces aeroplane engines for larger, long-haul planes. A huge amount of its revenue comes from servicing those engines, with business based on how many hours those engines spend in the air.

So it was encouraging to see so-called engine flying hours (EFH) grow to 83% of 2019 levels in the first half. EFH isn't expected to return to pre-pandemic heights until the end of 2024, and until that happens, there's a ceiling to how high Rolls Royce can fly.

Disposals and a huge restructuring effort have lightened the load of recent financial scars, and the transformation programme's showing early signs of success too - driving productivity improvements across the group's major divisions.

First-half underlying operating profits came in around double previous market expectations. That was driven by a sharp swing back to profitability in Civil Aerospace as commercial volumes pick back up, and higher demand and margins in the defence division.

Free cash flow's also jumped up to £356m at the half-year mark - seven times higher than markets had originally been expecting. That comes despite Rolls spending more cash building up its inventory levels to cope with the additional activity and constraints in supply chains.

Now it's back in positive free cash flow territory, Rolls has made good headway in pushing debt lower in the first half. But given the group's still sporting a negative equity position - meaning liabilities outweigh assets - we're sceptical about seeing any kind of dividend this year.

A multi-billion pound order book gives the group a good deal of visibility over future revenue. We expect the order backlog to grow further as the group benefits from a recovery in its end markets. It's also continued to win key contracts in its lucrative defence division.

Rolls' position in the defence and aerospace industry is enviable - high barriers to entry mean there are very few smaller competitors sniffing around. However, valuing that long-term opportunity is a challenge. Huge asset write-downs mean traditional valuation metrics - like Price/Book or Price/Earnings - don't tell the full story. For that reason, we've used Rolls' Price/Sales ratio in the box below to offer a valuation touch point as it indicates how much the market is willing to pay for each pound of expected sales. But it's not a perfect indicator since it doesn't account for debt or profitability - both of which are major points of focus for Rolls right now.

It looks like the worst is now over, but there's still plenty of work to be done. With no dividend on offer to make the wait more palatable, shareholders should be prepared to stomach some turbulence.

Environmental, social and governance (ESG) risk

The aerospace and defence sector is high-risk in terms of ESG. Product governance and business ethics are key risk drivers. Carbon emissions from products and services, data privacy and security and labour relations are also contributors to ESG risk.

According to Sustainalytics, Rolls Royce's management of ESG risk is strong. It has set up a safety, ethics & sustainability committee to oversee ESG issues and executive compensation is tied to performance on these issues. There is also a strong environmental policy, including a commitment to net zero and interim targets, and whistle-blower programme. However, ESG-related disclosure falls short of best practice.

Rolls-Royce key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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Written by
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 3rd August 2023