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Rolls Royce - profits fly higher on increased demand

Rolls Royce's full-year underlying revenues rose 15.9% to £12.7bn.

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In Civil Aerospace, Rolls-Royce's full-year underlying revenues rose 15.9% to £12.7bn. Much of the growth came from a recovery in the Civil Aerospace division, where a 35% improvement in large engine flying hours (EFH) drove a 26% increase in service revenues.

Underlying operating profits spiked 57.5% to £652m. Nearly half of this improvement came from a return to profit in Civil Aerospace. Power Systems also made a contribution, but profits in Defence were down and losses widened in the New Markets division.

Free cash flow increased to £0.5bn, from a free cash outflow of £1.5bn last year. Net debt fell from £5.2bn to £3.3bn due to disposals and improved cash flow.

Looking to 2023, the group expects underlying operating profit to be in the £0.8bn-1.0bn range. Free cash flow is also expected to land in the £0.6bn-£0.8bn range.

The shares jumped 18.3% following the announcement.

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.

While so called engine flying hours (EFH) were up 35% this year, they're still only at 65% of 2019 levels. It'll be another couple of years until EFH are back to pre-pandemic heights. 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 undertaken a huge restructuring effort which has lightened the load of recent scars. Disposals totalling around £1.5bn have been put towards restoring the balance sheet by paying down debt, which shot up during the pandemic.

All in, the leaner organisation has shown signs of strength. The group became free cash flow positive in 2022, after seeing £1.5bn of cash walk out the door the year prior. If cash inflows continue, the group will be able to keep pushing debt lower, going a long way in restoring our faith in Rolls' ability to stand on its own two feet. But given Rolls are still sporting a negative equity position - meaning liabilities outweigh assets - we're sceptical about seeing any kind of dividend this year.

Rolls' multi-billion pound order book gives the group a good deal of visibility over future revenue. 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 major points of focus for Rolls right now.

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 likely feel the sting of any 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
Derren Nathan
Derren Nathan
Head of Equity Research

Derren leads our Equity Research team with more than 15 years of experience in his field. Thriving in a passionate environment, Derren finds motivation in intellectual challenges and exploring diverse ideas within his writing.

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Article history
Published: 23rd February 2023