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Rolls-Royce plunges to a loss as pandemic pressures continue

The plane engine maker estimates that large engine flying hours will still not have fully recovered in 2022
March 11, 2021
  • The group swung to a £4bn underlying pre-tax loss in 2020
  • It also burned through £4.2bn of cash and is guiding to a £2bn free cash outflow this year

Amid the havoc wreaked by Covid-19 on international air travel, it will come as little surprise that 2020 was a dire year for Rolls-Royce (RR.). Indeed, the aircraft engine maker plunged to a £4bn underlying pre-tax loss last year – versus a £583m profit in 2019 – on the back of hefty exceptional charges. These include a £974m blow from work that will no longer be needed on long-term service agreements and a £1.7bn hit from revaluing its US dollar hedge book.

Prior to the pandemic, Rolls derived more than half of its underlying revenue from civil aerospace, making engines for plane manufacturers such as Boeing (US:BA) and Airbus (FR:AIR), and providing aftermarket services. As these giants cut their production rates, Rolls’ large engine deliveries almost halved in 2020, to 264, and the group says they are “expected to remain at the current lower levels for the next few years.”

Beyond lower demand for new engines, the collapse in global air traffic has highlighted the fragility of Rolls’ ‘power-by-the-hour’ business model. This means that its engines are typically sold at a loss and generate revenue according to how long they spend up in the air. But as airlines grounded their fleets, Rolls’ large engine flying hours (EFH) plummeted by almost 60 per cent in 2020.

Under its base case scenario, the group estimates that EFH will only recover to 55 per cent of pre-pandemic levels this year. Despite hopes that international travel will rebound as the vaccine rollout continues, Rolls has downgraded its expectations for 2022. It estimates that EFH will still only be at 80 per cent of normal levels, down from a previous forecast of 90 per cent.

The deterioration in EFH led to a £4.2bn free cash outflow last year. This also reflects a £1.1bn hit from halting invoice discounting, which is the practice of selling trade receivables to banks who go on to recoup the money owed from suppliers so that Rolls can receive cash more quickly. The group is guiding to a £2bn free cash outflow this year as well, although it is still aiming to generate at least £750m of free cash flow in 2022.

That cash target includes an anticipated £100m-200m of costs relating to Roll’s Trent 1000 engines, which have suffered from premature blade deterioration. The group recorded £524m of in-service cash costs in 2020 to cover repairs and compensate customers for disruption, although it has managed to reduce the number of Trent 1000 groundings due to durability issues to zero.

Excluding lease liabilities, Rolls has shifted from £1.4bn of net cash to £1.5bn of net debt, which includes the £2bn proceeds of a heavily discounted rights issue. That fundraising was part of a £5bn rescue package that also included a £2bn bond sale and £1bn of additional loans. The group now has £9bn of liquidity to hand, which it says is sufficient to see it through the next 18 months.

Net debt is expected to hit £4bn this year, although Rolls is aiming to shore up its balance sheet with more than £2bn-worth of asset disposals. Spanish subsidiary ITP Aero – which makes engines for the Eurofighter Typhoon jet – is up for sale and Rolls says that it is in talks with “a number of potential buyers”. ITP had attracted the interest of information technology and defence company Indra Sistemas (ES:IDR) in 2019 before talks fell through.

Meanwhile, the group struck a deal in February to sell its marine engine business Bergen to Russian engineering company TMH for €150m (£130m). But the sale has now been paused as the Norwegian government investigates the deal based on national security concerns. It is unclear how long this probe will last and is another unwanted headache for Rolls.

In response to the aviation crisis, Rolls is restructuring its civil aerospace business, aiming to make annualised savings of £1.3bn by the end of 2022. It plans to axe 15 per cent of its global workforce by 2022, with 7,000 out of a total 9,000 job cuts having already been made.

The only bright spot in Rolls’ results was its defence business where higher aftermarket revenues from its ‘LiftSystem’ technology – which enables fighter jets to take off and land without a long runway – propelled the division’s operating profit up by 8 per cent to £448m. With an order intake of £2.4bn, the defence business has visibility of over 90 per cent of expected revenue for 2021.  

Still, this won’t be able to compensate for a multi-year downturn in civil aerospace, with the International Air Transport Association (IATA) forecasting that global passenger travel will not return to pre-pandemic levels until 2024. Rolls is also weighted towards the widebody aircraft that are used for long haul flights, and intercontinental travel is expected to rebound more slowly than regional and business aviation. Underlying earnings are expected to recover to a loss of 2p a share in 2021.

It has been a traumatic ride for Rolls’ shareholders since the beginning of last year, with the shares more than halving in value. They have recovered from a low of 35p in October but are still languishing at just 114p. Sell.

Last IC View: Sell, 116p, 01 Oct 2020

ROLLS-ROYCE (RR.)   
ORD PRICE:114pMARKET VALUE:£ 9.54bn
TOUCH:113-115p12-MONTH HIGH:194pLOW: 35p
DIVIDEND YIELD:NILPE RATIO:NA
NET ASSET VALUE:59p*NET DEBT:155%
Year to 31 DecTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
201615.0-4.64-75.64.02
201714.83.9063.24.02
201815.7-2.95-44.34.02
201916.6-0.89-23.71.60
202011.8-2.91-53.0nil
% change-29---
Ex-div:na   
Payment:na   
*Includes £5.1bn in intangible assets or 61p a share. NB: EPS and DPS figures for 2016-19 have been adjusted to take account of Oct 2020 rights issue