Rolls-Royce buoyed by increase in large engine flying hours

It’s too early to be handing out any cigars, but half-year figures for Rolls-Royce (RR.) suggest that the engineering giant may have put the worst behind it after several years characterised by engine recalls and the deleterious financial effects of the pandemic.

The group had foreshadowed its interim numbers and raised the estimate for full-year underlying profit from a range of £800m-£1bn, to between £1.2bn-£1.4bn. Adjusted operating profit came in at £673mn at the half-year mark, against £125mn in HY 2022, while the underlying margin quadrupled to 9.7 per cent. Free cash flow also returned to positive territory, capping a strengthening interim financial performance that outstripped consensus expectations.   

Nowhere is the impact of the focus on commercial optimisation better illustrated than in the Civil Aerospace business, where the operating margin came in at 12.4 per cent against negative 3.4 per cent last time around. Numbers benefited from increased large spare engine sales, coupled with cost efficiencies.

Not to be outdone, underlying revenue at the Defence and Power Systems segments increased by 15 per cent and 24 per cent respectively at constant currencies, while the former business also saw new orders worth £2.7bn through the period under review.

It’s early days, but the practical measures adopted by new chief executive, Tufan Erginbilgic, seem to have had a galvanising effect, although it obviously helps that more people are spending more time in long-haul flights. Air travel passenger numbers have almost returned to pre-pandemic levels, according to June figures from the International Air Transport Association (IATA). Rolls-Royce notes that large engine flying hours increased from 65 per cent of 2019 levels during the first quarter, to the current rate of 83 per cent, with full-year guidance of between 80-90 per cent of 2019 levels left unchanged. The lifting of travel restrictions in China has had a notable impact.

Sales also trumped analyst forecasts. The group registered 240 large engine orders through the half, compared with 96 in the same period a year ago, with a sizeable deal from Air India for 68 Trent XWB-97 engines chief among them. The order book now stands at 1,405 engines with guidance for 400-500 deliveries through 2023.

It may seem curious to describe a business established in 1904 as a “work-in-progress”, but Erginbilgic’s strategic focus will become clearer in November when management publishes the outcome of its strategy review. It is to be hoped that, by then, the group will have received more clarity from the UK government on the prospective roll-out of small modular nuclear reactors in UK. The interim figures have forced a reassessment of analyst guidance, but for now the consequent ratings are of lesser importance than the unfolding narrative. Speculative buy.

Last IC view: Buy, 128p, 23 Feb 2023