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Rolls Royce – beats profit guidance

Rolls Royce’s full-year underlying revenue rose from £12.7bn to £15.4bn.

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The rise in revenue was fuelled by double-digit growth in all three of its core divisions, with particularly strong growth in Civil Aerospace.

Underlying operating profit grew by £0.9bn to £1.6bn, ahead of the group’s prior guidance. This was largely driven by “materially higher margins” across all three core divisions. Civil Aerospace margins significantly improved to 11.6%, helped by strong consumer demand and improved cost efficiencies as volumes increased.

Record free cash flow of £1.3bn, up from £0.5bn. Net debt improved from £3.3bn to £2.0bn.

In 2024, the group expects underlying operating profit and free cash flow of between £1.7-2.0bn and £1.7-1.9bn respectively. Engine Flying Hours (EFH) are expected to rise from 88% to between 100-110% of 2019 levels.

The shares rose 7.6% following the announcement.

Our view

Rolls Royce’s full-year results capped off a stellar year for the FTSE 100’s top performer of 2023. Underlying operating profit and free cash flow came in ahead of the group’s prior guidance, highlighting the company’s much improved operational performance.

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 hear so-called engine flying hours (EFH) grow to 88% of 2019 levels last year. That figure’s set to soar to new heights in 2024, with the group expecting EFH to hit 100-110% of 2019 levels.

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. More disposals are on the cards, with Electrical division likely first on the chopping block as the group looks to free up cash for other parts of the business.

Free cash flow jumped up to a record £1.3bn, 27% ahead of market expectations. That comes despite Rolls spending more cash building up its inventory levels to cope with the additional activity and constraints in supply chains.

With its healthy free cash flows, Rolls has made good headway in pushing debt lower. Markets are forecasting a reinstatement of the dividend this year, but given the group’s still sporting a negative equity position - meaning liabilities outweigh assets – this isn’t guaranteed.

Rolls' position in the defence and aerospace industry is enviable - high barriers to entry mean there are very few smaller competitors sniffing around. And a multi-billion pound order book gives the group a good deal of visibility over future revenue.

The group’s mid-term guidance, which lays out targets for 2027, now looks well within reach. By the end of 2024, Rolls expects to have delivered more than 50% of the improvements set out for margins, profits and free cash flows. But keep in mind that these improvements are expected to be front-loaded, so the pace of progress is likely to slow over the years.

The group’s currently trading well ahead of its long-term average on a forward price-to-earning basis. But this isn’t a perfect measure as the long-term average has been distorted by Covid-19 disruption. Mid-term targets look achievable, with scope for some positive surprises in our eyes, but there are no guarantees. With no dividend currently on offer to make the wait more palatable, shareholders should be prepared to stomach some turbulence along the way.

The author holds shares in Rolls Royce.

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, based on the previous day’s closing values. 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: 22nd February 2024