It’s easy when arriving at packed airports with crowded shops and restaurants to think that the effects of Covid-19, at least economically, have largely dissipated.
For short-haul flights, especially in Europe, there’s lots of evidence that this is indeed the case. In the week ending 26 October, the number of flights from European airports reached 91 per cent of 2019 levels, according to Eurocontrol. Intra-European flights were only 7 per cent lower than pre-pandemic numbers.
Yet the persistently higher numbers of mask-wearers in airports shows that many people rightly remain cautious about new waves of infection. This cautiousness also extends to certain governments, and a look beyond Europe shows the aviation market has a long way to go before things are back to normal.
The most recent monthly figures from the International Air Transport Association, a global trade body representing airlines, shows flights are still down by more than a quarter compared with 2019. In the Asia-Pacific region, flight activity is 62 per cent lower than pre-pandemic levels.
This matters to Rolls-Royce (RR.), which made more than half of its pre-coronavirus revenue from its civil aerospace division. It gets paid through long-term contracts based on how many hours its Trent jet engines are in service. The engines are particularly popular on larger jets such as Airbus’s A380 and Boeing’s 787 Dreamliner models, which are the workhorses of long-haul routes.
In 2019, the company invoiced for 15.3mn large engine flying hours, but the pandemic severely clipped its wings – business fell to just 43 per cent of this level in 2020 and it has taken much longer to recover than expected.
In 2021, the company was forecasting large engine flying hours would recover to 80 per cent of 2019 levels this year. It has since revised down this figure and last Thursday the company said that the four months to the end of October had picked up to just 65 per cent, pushing the year-to-date figure up slightly to 62 per cent.
Thankfully, other parts of the business are enjoying “robust” demand levels, notably defence, which has grown from contributing 23 per cent of pre-pandemic revenue to 31 per cent last year.
This isn’t directly linked to the conflict in Ukraine – the company expects “no material benefit” from increases in government defence budgets this year, given that the engines it develops for military transport and aircraft have a much longer life cycle.
However, increased spending is undoubtedly beneficial for the long-term outlook not only for its defence division but also Power Systems, which provided 25 per cent of last year’s revenue and has recently won contracts to provide engines for UK armoured vehicles and gensets for German naval frigates.
The key part of its third-quarter trading statement was the fact that it stuck to its guidance, despite the massive headwinds it faces. The targets Rolls' management have set for themselves this year – low-to-mid single-digit revenue growth, a flat underlying operating profit margin of 3.8 per cent and “modestly positive” free cash flow aren’t exactly exciting.
Yet after a two-year period where the company has recorded an accumulated pre-tax loss of £3.2bn and a free cash outflow of £5.7bn, an unspectacular year in which the massive haemorrhaging of cash is halted is in itself a cause for celebration.
Progress is also being made in other areas – the €1.6bn sale of its ITP Aero arm, confirmed in September, has allowed it to repay a £2bn floating rate loan backed by UK Export Finance.
Outgoing chief executive Warren East said the repayment “marks a milestone recovery in the strength of our balance sheet”.
It still has some way to go – it was carrying net debt of £5.1bn at the end of June, so sustained cash generation will be key. It has time on its side – the next debt repayment milestone isn’t until 2024, when £500mn falls due.
A massive restructuring exercise which has taken place over the past couple of years, which saw 9,000 roles cut in a bid to achieve £1.3bn of savings, means that it is better positioned to convert more of its cash into profit as the civil aerospace business picks up.
Its new business unit has made real progress in progressing plans for small modular nuclear reactors, but this should be seen by investors as a bonus rather than being core to the investment case. Funding from government and Qatar's sovereign wealth fund de-risks its own investment into a model which still attracts some scepticism – the Australian Conservation Foundation last month describing SMR technology as “uncertain and unproven”.
In any case, the UK needs to do something to improve its energy security, though, and the spectacular mess that’s been made in developing the next generation of larger reactors suggests smaller versions are worth pursuing.
