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Rolls Royce - on track for full year

In Civil Aerospace, Rolls Royce said large Engine Flying Hours (EFH) are around 65% of pre-pandemic level...

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In Civil Aerospace, Rolls-Royce said large Engine Flying Hours (EFH) are around 65% of pre-pandemic levels in the four months to the end of October. There has been a stronger recovery in the US and Europe, partially offset by reduced travel in China because of restrictions. Within the division, Original Equipment deliveries are at the lower end of the expected range.

There has been ''robust'' demand in Defence, and Power Systems saw a record order in-take in the year to date. Investment is continuing in New Markets.

Rolls Royce completed its £2bn disposal programme in September, which was used to pay down nearer-term debt obligations. The group has £4bn of drawn credit, which needs repaying between 2024 and 2028. All drawn debt is on fixed-interest rate terms. Many of Rolls' long-term contracts contain inflation-linked pricing clauses based on standard indices for energy, materials and wages - which helps to offset the effects of rising costs.

More detailed full year results are expected on 23 February.

The shares fell 4.6% following the announcement.

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

Our view

Rolls Royce will be one of the last to fully recover from the effects of Covid. It 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.

It's going to be another couple of years until so-called engine flying hours are back to pre-pandemic levels. This is being held back further by ongoing restrictions in China. As long as zero covid policies remain in place in the region, things will be sluggish. And until global flight hours are back to pre-pandemic volumes, there's a ceiling to how high Rolls Royce can fly. For all the challenges, the group is doing reasonably well within the elements of the situation it can control.

It's undertaking a huge restructuring effort which is lightening the load of recent scars. A huge disposal programme has completed, with proceeds, said to total around £2.0bn, to be put toward restoring the balance sheet by paying down debt which shot up during the pandemic.

Debt is on a fixed interest basis, which is heartening in the current environment. And clauses in customer contracts mean Rolls is largely able to increase its prices in line with inflation, which helps offset the worst of soaring costs.

All in, the leaner organisation has shown signs of strength. Two years ago, the group saw £4bn of cash walk out the door, last year that fell to £1.5bn and at the half year mark it was in touching distance of break even. Barring any significant disruptions, the group is on track to be free cash flow positive this year. This should help debt make its way lower and would go a long way in restoring our faith in Rolls' ability to stand on its own two feet.

Rolls' multi-billion pound order book gives the group a good deal of visibility over future revenue as well. And it's backed by reliable defence contracts. This is a small but mighty part of Rolls' portfolio. It's a diamond in the rough, and being that it supports defence departments around the world, some level of income for the company is basically guaranteed, particularly in the current climate.

Rolls' position in the defence and aerospace industry is enviable - high barriers to entry means there are very few smaller competitors sniffing around. However, valuing that long term opportunity is a challenge at the moment. Huge asset write-downs mean traditional valuation metrics - like Price/Book or Price/Earnings - don't tell the full story for Rolls-Royce stock. 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 troublesome for Rolls right now.

Rolls is also barred from paying dividends until at least 2023 as part of its loan terms. Even without that red tape, the group couldn't pay a dividend because it's sporting a negative equity position - meaning liabilities outweigh assets.

It appears the worst might be over for Rolls, but there's still work to be done. While aviation's made a comeback, it'll be the first to feel the sting of a prolonged economic downturn. With no dividend on offer to make the wait more palatable, shareholders should be prepared to stomach some turbulence.

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
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 3rd November 2022