In a short trading update ahead of its AGM today, Rolls-Royce said it’s had a strong start to the year and all divisions are performing well.
In Civil Aerospace, large engine flying hours rose to 110% of 2019 levels in the first quarter.
The Defence and Power Systems divisions, which account for around 25% of group revenue each, have both seen strong order intake in the period.
While tariffs have caused increased uncertainty in the industry, Rolls-Royce expects to be able to offset their impact on its business. As a result, full-year guidance had been reiterated, with underlying operating profit and free cash flow both expected to be between £2.7-2.9bn.
£138mn of the ongoing £1bn share buyback programme was completed at the end of March, with the remainder set to be completed by yearend.
The shares rose 2.5% in early trading.
Our view
Rolls-Royce delivered a positive trading update, with all divisions performing well in the first quarter. Alongside strong order intake, full-year targets remain on track.
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-called engine flying hours (EFH) are now cruising at 110% of 2019 levels. That figure’s set to soar somewhere between 110-115% of 2019 levels by the end of the year as more of its engines take to the sky and demand for long-haul travel remains strong.
We’ve also been impressed with the stark changes made elsewhere in the business. CEO, Tufan Erginbilgic, is a no-nonsense leader. He’s delivering on his promise to transform Rolls into a leaner, more focused company, and it’s reaping plenty of rewards.
From an operational standpoint, layoffs, contract renegotiations, process changes, and increased use of data to drive efficiencies have put Rolls on a much healthier platform. As a result, margins have moved much higher, helping to convert the increased flying hours and revenue into profits.
Rolls also has exposure to the defence sector, making up around 25% of group revenue. Given the current elevated-threat environment, defence budgets across many countries are on the rise. With positions in combat aircraft and nuclear submarines, Rolls-Royce looks well-placed to capture some of the increased spending.
Despite all the positives, there have been question marks about some of its newer-generation engines, which appear to be underperforming in sandier climates. Attempted fixes are in the pipeline, but if the group can’t iron out these issues, it could eat into future profits.
Rolls reckons it can offset much of the direct impact of tariffs on its business. But the indirect impact could see some weakness among its customers, and that’s largely outside of the group’s control.
The balance sheet looks much stronger than it has for some time, giving management the confidence to reinstate dividend payments and announce a £1bn share buyback programme. But as always, no shareholder returns are 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.
High expectations for growth have earned Rolls a premium versus its peers. We think that’s well deserved and the underlying business looks healthy, but it does increase the risk if management doesn’t deliver progress on time. And of course, there are no guarantees
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
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