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Rolls Royce - trading in line with full-year guidance

Rolls Royce released its AGM trading update, with the group benefitting from "recovery and growth" in its end markets.

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Rolls-Royce released its AGM trading update, with the group benefitting from "recovery and growth" in its end markets.

In Civil Aerospace, large engine flying hours (EFH) were 83% of 2019 levels in the first four months of the year. As previously guided, Rolls expects this figure to be remain in the 80-90% range across the full year.

In Defence, Rolls has been awarded key contracts to provide nuclear reactors for the AUKUS submarine programme, as well as engines for the next generation of US Army helicopters.

In Power Systems, revenue grew thanks to high demand for aftermarket services and as a result of high order intake last year. Pricing on new orders in this division is improving, which the group hopes will drive margins up, with these benefits expected to pull through in the second half of the year.

Full-year guidance remains unchanged. The group expects underlying operating profit between £0.8-£1.0bn and free cash flow between £0.6-£0.8bn, with the latter being weighted to the second half of the year.

The shares fell 2.6% 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.

So it was encouraging to see so-called engine flying hours (EFH) rise from 65% to 83% of 2019 levels in the first four months of the year. Despite this, it'll be another couple of years until EFH returns 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.

Disposals and a huge restructuring effort have lightened the load of recent scars. All in, the leaner organisation's showing signs of strength. Now it's back in positive free cash flow territory, it should be able to keep pushing debt lower, which stood at £3.3bn at the last count. But given the group's 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. Given that this division 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 mean 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.

After just four months of trading, it was reassuring to see the positive full-year profit and cash flow guidance reiterated. The worst is likely over, 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.

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 a whistle-blower programme. However, ESG-related disclosure falls short of best practice.

ESG data sourced from Sustainalytics

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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: 11th May 2023