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We have also extended the time horizon for peak earnings and share price from 2028 to 2030 Despite the forecast increases, our 1-year and 3-year price targets only change fractionally, to 560p from 550p and to 810p from 820p – partly because the move in the peak to 2030 flattens the gradient of the trough to peak target line Notionally there is enough downside at 3-years to justify a Sell recommendation, but we explain in this report that, unlike a progressive multi-year cyclical recovery and growth pattern, re-ratings are often sudden and the share price’s move directly to our peak target value (of just over 1050p in 2030) is not surprising – it suggests though that there is not much left to play for and a downgrade to Hold is unavoidable Civil aviation is notably cyclical, with a typical trough to peak to trough period of around 10 years – we note that out 2030 peak year would be 10 years on from the 2020 low, implying an unusually long run – this represents a risk to our targets The downgrade is reluctant – it has been a good run from our upgrade to Buy at 111p almost exactly four years ago – but at the same time we are nervous about just how far forward the share price is anticipating, with apparently little allowance for anything going wrong Our concerns are informed by almost 40 years of analysing the sector through four major recessions – Rolls-Royce is far more robust now, but it is also carrying much higher valuation multiples and the underlying industry dynamics have not changed
Rolls-Royce Holdings plc
The meeting and call is at 9AM UK timeExtremely strong profit and earnings performance, ahead of consensus by over a third, driven mainly by Civil Aeroengines, but helped by a strong performance from PowerThis was matched by free cashflow, which beat our expectations by around 40% and accompanied by a big interim dividendThis performance prompted an increase in guidance for both profits and cashflow for the yearRecently increased medium term (2028) guidance is unchangedNotably the statement goes beyond reiterating the medium-term guidance to say, “We see these targets as a milestone, not a destination, with substantial growth prospects beyond the mid-term.”There is a lot that is RR specific going on here, but it is also no doubt benefiting from the aftermarket windfall (new widebody aircraft are in short supply too, not just narrowbodies, and RR’s OE engine guidance has been narrowed to the lower end, though engines are probably not the pacing item of OE widebodies)However, RR points out the 1H performance and the guidance are despite continuing supply chain problems and the recent tariff issuesWe said in our preview that RR need forecasts to go up to carry the share price in the light of very high prospective multiples – it looks like we just got that forecast upgrade
Rolls-Royce reports 1H25 results on Thursday 31 July, with a meeting and call at 9AM UK timeConsensus half year forecasts (first table) look a little strange, with lower Civil Aeroengine EBIT and group pretax profits in 1H25 than 1H24 – we conjecture this may be the result of a small sample size for Bloomberg and Reuters’ data, as we have no particular reason to expect a weaker 1H25, particularly after the company reported in its AGM statement on 1 May 2025 that the year had got off to a strong startIt is worth noting though that RR reported higher margins in the first half for Civil Aeroengines in both 2024 and 2023, and we also feature that in our forecast for this year – it is dependent on mix, mainly the timing of OE deliveries and overhauls, though, which is hard to forecastOur first half forecasts imply that RR will report 46% of our full year forecast sales in 1H25, which is the same as 2024, and 45% of full year operating profits, versus 47% last year, which seems to pass the reasonableness testThe share price has had a remarkable performance since 2H22 and is up 9.3x in the four years since we upgraded to Buy, a little early as so often, at 105p in August 2021 – the last leg in particular, looks uncomfortably exponentialIt is notable that RR management has until recently taken every opportunity to tell the market that its recovery may come faster than expected, and as recently as the full year 2024 results in February it said; “Based on our 2025 guidance, we now expect to deliver underlying operating profit and free cash flow within the target ranges set at our Capital Markets Day, two years earlier than planned.”But in the same statement it also upgraded the medium term (2028) guidance, and said “These mid-term targets are a milestone, not a destination, and we see strong growth prospects beyond the mid-term.”We can see where the further upgrades might come from, with component upgrades to large civil engines giving longer time on wing between overhauls, especially in adverse environments such as desert areas – this should reduce the future annual cost of overhauls to RR without reducing its annual engine flight hour receipts under long term service agreements
Rolls-Royce^ (RR, Hold at 754p) - In line AGM update
Rolls-Royce^ (RR, Hold from Buy at 733p) - Strong FY24A but turbulence to come
Strongly beat forecasts, especially Civil Aeroengine profits and total free cashflow EPS and DPS both more than 10% better than our forecast Guidance for 2025 well above our profit forecast and upper end of guided free cashflow range in line with our forecastMid-term (2028) guidance operating profit above our forecasts by c10% at low end and we are in the middle of the 2028 free cashflow guidanceGuidance to number of overhauls higher in 2025 and 2028 than our basis, which helps to explain higher profits (revenue and profit is recognised on work done, not flight hour receipts) Implies lower cost per overhaul which helps both profits (assumed margin on contract will go up) and cashflow (less cash out on each overhaul) Overall, very strong results, supportive of our targets and recommendation, and of our assumption, underlying our medium-term targets, that RR will be rerated to at least match European peers Safran and MTU
2024 is likely to be the last year of recovery from a low base, with strong engine flight hour (EFH) growth and a tailwind from the falling away of specific costs2025 will bring more moderate EFH growth, and less tailwind from specific costs, though cash operating profits should still grow well, and low margin new engine deliveries will be limited by the widespread supply chain and labour issues – we expect progress to look more normal from 2025 onwardsThe company is adding to its organic momentum by its own efforts to extend time between overhauls, reduce overheads, gain pricing, and to renegotiate bad contractsThe transition to more moderate growth does not necessarily mean the share price performance is over, but the rest of the upside to our 820p 3-year target rests on the assumption that RR will continue to be rerated to valuations closer to its European aeroengine peers; Safran and MTURR still looks undervalued relative to Safran on EV/Sales and on free cashflow yield, and highly undervalued relative to MTU on free cashflow yieldThey key to continuing the rerating lies in clean execution with no major adverse surprises – RR’s current management team have been good at thisGiven the attractive relative valuations, we are sticking with our Buy recommendation, looking to the medium term upside, and ignoring the degree to which RR’s share price has moved ahead of our near term target
• RR has enjoyed an astonishing performance, with the share price rising 6-fold in two years, as free cashflow has risen by over £800m each year in 2023 and 2024E• The obvious question that follows is as to the sustainability of this performance, and that has led us to examine the sources of the financial performance more closely• We have disaggregated the cashflow and find that the biggest drivers are cash profits and the growth in the long-term service agreement net liability – the latter arises because RR’s cash in from engine flight hour payments continues to exceed the amount it has to spend on overhauls to satisfy those contracts each year – we forecast this will continue to be positive for some years to come, but the flight hour and overhaul trends will converge, so the cashflow from this source will tend to stabilise at a lower annual level than in 2023• Profits growth also comes mainly from the civil aeroengine aftermarket, especially LTSA revenues, and this too should continue to grow, though the aggressive recovery phase, from a negative base, is probably largely done – similarly the tailwind from falling cash outlays on one-off issues, such as the Trent 1000 problems and unwinding excess hedge positions, is also tailing off• So far though there has been little sign of the big working capital outflows caused by the pandemic flowing back in – this may yet come, but the timing is uncertain, and the need to support a fragile supply chain and to hold bigger stocks of parts than before may not fully reverse, even when the supply chain issues are notionally fixed• We have revised and raised forecasts and that combines with the passage of time to lead us to raise targets to 550p at 1-year and 820p at 3-years, up from 400p and 665p respectively – we retain our Buy recommendation
Guidance from half year results in August unchanged, and error bars around main numbers (see table below) are also unchanged – these are still 5-10% with less than two months of the year left to goThat is less surprising than you might expect as cashflow and profits recognition in the aerospace industry is heavily concentrated in the last few weeks of the year and the actual outcome can be affected by small shifts in timingUse of “Ch” word (challenged) in respect of aerospace supply chain both in the CEO’s summary and in the main body, but seemingly not concerned about it sufficient to threaten the medium-term recovery targets which are also unchangedIt is a huge problem for many other industry players in similar and related activities but widebody production and flight hours still lags narrowbody recovery and this has probably given RR more time to adapt – even so, it is hard to believe that RR is not feeling the effects somewhere in its financial performanceThe statement repeats previous mention that performance is “front-end loaded”, but RR has not changed the timing of the medium-term targets or the degree, so the front-ending would suggest a non-linear performance, with bigger increments earlier, and then smaller increments towards the targetThis helps to explain the difference between guidance and our forecasts, which are well below the raised guidance for 2024, but roughly in line with the medium-term 2027 guidance (see guidance table later)RR seemingly remains keen on civil nuclear, a segment in which it has only been a peripheral player in the past, but for which it is now offering the misnamed small modular reactor (SMR), which is in its case a pair of submarine sized PWRs with about 470MW of capacity – this is small compared to the giant EPRs (European Pressurised Reactor which has 1.6GW per unit) being built, or mostly not built around Europe and the UK, but it is actually about the same size as the recently retired UK first generation Magnox reactors from the 1950s and 60s which it may replaceIt is negotiating a deal in Czechia to develop a fleet of at least 6 SMRs, which is ostensibly good news, but given the history of the industry we trust RR will not take this on a fixed price basisIt is hopeful of a deal in the UK, probably initially to develop a pilot programme of a handful of reactorsNone of this really moves the dial relative to its civil aeroengine business thoughIn the dominant Civil Aeroengine segment the recovery of engine flight hours is the revenue driver and the profit outperformance seems mainly to flow from a combination of this, which brings higher flight hour receipts, though no higher than expected, and a lower than planned level of overhauls, and lower cost per overhaul, which reduces, or at least defers, anticipated cash outflows to pay for the overhaulsThat is resulting in the better near-term performance than expected, but RR seems to expect the steady state position in the mid-term to be the same as previously anticipated, implying a similar rate of overhaul and cost per overhaul to previous expectationsSome of the near-term savings on overhaul costs may be an unexpected benefit of the huge costs incurred from early overhauls of Trent 1000s from when that programme went expensively wrong, mainly from 2018-20, but with a tail of cost that is just finishing nowThere have been some other Trent 1000 issues more recently, mainly with the larger 1000 TEN variant on the Boeing 787-10, which RR is in the process of fixing – this is one place where supply chain issues may be hurtingThis is a small sub-fleet though and the financial consequences are likely to be relatively small – RR expects it to be resolved once upgraded parts are available in sufficient quantityThere is still plenty of upside to our 3-year target, which is based on the assumption that RR rerates to a typical Safran peak cycle rating this cycle, instead of the much lower ratings of previous cycles, when RR continually struggled with cashflow and profitability as it built the market share which it is benefiting from nowRR is well past our 1-year target, but that is not surprising as the rerating process is not linear and, in this case, it is the 3-year target which matters
Rolls-Royce^ (RR, Buy at 560p) - Trading update - EFH lower end of range
Rolls-Royce^ (RR, Buy at 485p) - Transformation continues at pace
RR is a complicated beast, and results require significant work and time to unravel, so for the moment we are just offering a summary of the main points discussed at the 1H24 meeting, plus some initial analysisPoints emerging include:Mix pressures in 2H24 suggest it may be flat on an extremely strong 1H24, but that still drives a 20% FY24 upgrade in profits and cashflow guidanceRR is not raising medium term (2027) guidance just yet, but says it may get there faster, which would be an implied upgrade for 2025-26Future cashflow looks set to continue to come from profits and the LTSA balance, as it did in 1H24, but probably not much from working capital – the ratios may improve but the absolute amounts not by much, constrained by the practical impacts of supply chain pressuresCapital structure seems to lean towards modest net debt (1-1.5x Net Debt:EBITDA) but could encompass a period of net cash in the nearer termManagement is keen to emphasise that RR is less risky than before because of its broader spread of profits and its lower fixed costsWe also summarise a number of smaller issues
The call/meeting is at 10.30AM UK timeVery strong 1H results, especially large beats and big year on year performances in free cashflow and Civil profitBig guidance increase and promise of resumed dividend (at 1/3 distribution) at FYPromises 30-40% distribution in future yearsGuidance indicates similar 2H to 1H – may imply further upside risk in 2H RR attributes flatter 2H to some sequential margin pressure in Civil from aftermarket mix and similarly in Defence, plus more lower margin OE in DefenceVery confident statement overallFree cashflow party attributable to better working capital – the big lever that had been missing from previous guidance – potentially a lot more to come if ratios can be normalisedNo raise to engine flight hour guidance so financial raise implicitly internally generatedHigher tax charge than expectedNew guidance well above our 2024 forecasts
1H24 PreviewRR reports 1H24 results on Thursday 1 August, with a call/meeting at 10.30AM UK timeIn its May AGM statement RR said the performance to date “provides further confidence in our guidance for 2024.”RR’s FY24 guidance is an odd combination of very detailed on a lot of the complicated financial and operating variables, and very broad on the big operating profit (£1.7-2.0bn) and free cashflow (£1.7-1.9bn) numbersRR assumes the critical EFH (engine flight hours) for large widebody engines will be at 100-110% of 2019 levels, but it was already at 100% in the first few months of the year before the AGM statement, making the FY assumption seem conservativeHowever, some airlines (LH, American, Ryanair) have recently been reporting falling yields (fares),so perhaps RR was either being wisely cautious in May, or was already hearing some more negative feedback from airlines, or both – we will listen for RR commentary on the current market outlook with interestThe half year consensus is more optimistic than our numbers, but RR remains complicated to forecast, especially on a near term basis. It has also had a strong tendency towards seasonality in the past, with a heavy 2H weighting – management is seeking to balance this better, but the extent to which that has been successful is not yet knownRR said in its AGM statement that it expected “a broadly balanced weighting for both profit and cash flow across the year.”Under our forecast 46% of FY 24 sales are in 1H24, versus 45% and 42% in the last two years, and 44% of profits, versus 42% and 24% - thus RR’s 2H weighting in our forecast is now no more than normal for an aerospace and defence contractorThe AGM statement also said that RR had taken the opportunity to pay down some borrowing facilities, including some expensive ones dating back to the pandemic induced crisis, which should reduce the average cost of debt and the interest chargeWe believe that net cashflow in 1H24 should have been enough to put RR in a net cash position as of the end of 1H24, if leases are excluded from net debtGeneral enthusiasm has taken RR past our 1-year target, though we note some recent consolidation – our 3-year target is based on the assumption that RR will re-rate in the same way as Safran did in the last upcycle, and for the same reasons, primarily a demonstrable improvement in quality of earnings and significantly lower riskSuch a re-rating will take time though, so we expect RR to move towards that 3-year target progressively and, if anything, it may continue to pause for breath in the near term
Rolls-Royce^ (RR, Buy at 428p) - Half year trading update
2023: reaping the first fruits of the group''s transformation There was a lot to like in Rolls'' FY 2023 results, including a 40% beat in H2 EBIT from both Defence and Power Systems and a very strong organic contribution from civil aftermarket, boosted by flight hour recovery and pricing. Overall, the demand environment remains favourable and is probably helping management implement the new action plan, which is beginning to deliver. 2024 guidance (on average 9% above consensus on EBIT and 6% above on FCF) seems to continue that momentum. A few points of concern diminish a strong performance Our primary point of concern is the unexpected supply chain headwind, eating GBP410m of 2023 profit through new provisions for onerous contracts. This means that progress on contractual renegotiations did not deliver to the bottom line. Second is the contribution of RandD cuts to margin increase (PandL RandD/sales ratio down 220bps to a 10-year low, underpinning most of the Defence margin increase). This probably reflects an ongoing cultural change at Rolls. Still, long-term investments may not stay contained much longer without impairing the group''s long-term future. What prevents us from being more constructive on an interesting value case? We have raised our EBIT forecasts by 3% and 7%, respectively, for 2024-25, with higher EPS increases due to lower financial expenses. The increase in our fair value from 313p to 350p reflects a reduction in the time discount of our SOTP. While profound transformations are clearly at play in the group, we need more granularity on the drivers of profits and cash over the coming years to value more than the bottom end of the group''s 2027 target ranges. We reiterate our Neutral rating.
Rolls-Royce^ (RR, Buy at 330p) - Momentum likely to continue
Rolls-Royce^ (RR, Buy at 330p) - FY23A Results - Excellent Progress
Solid start to the year for Airbus deliveries In January, we identified 31 deliveries at Airbus, including 26 A320 family aircraft, three A220 and two A330neos. This marks a return to a fairly normal start-of-the-year delivery schedule, comparable to the 30 units delivered in Jan 2022 and much improved on the 20 deliveries of Jan 2023, which was affected by significant supply chain disruption. This supports our view that supply chain challenges remain relatively under control at Airbus, and we expect the company to be able to deliver aircraft in the range of 810-820 this year after a 15-unit beat to guidance at 725 in 2023. Execution situation remains stretched at Boeing We expect 27 deliveries at Boeing in January, down from 38 units in Jan 2023 and including 25 737 MAX. The delivery situation will likely remain complex in the near future, with no guidance set so far for FY 2024 and a production quality control system under scrutiny by the FAA. While Boeing still has c250 MAX in inventory to deliver, it is facing a temporary production cap on its 737 MAX and has so far been requested to perform two series of inspections and maintenance operations on its 737 MAX9 as well as on 50 shipsets of fuselage sent by its aerostructure supplier Spirit. Uneven situation in business jets We did not see any Falcon jet delivery at Dassault in January. Following a significant delivery miss at the company in 2023 (26 units reached vs 35 targeted), this hints at continuing difficulties in supply chain management as well as challenges in performing the cabin customisation and aircraft modification certification on the Falcon 6X, which we believe has still not been delivered to a commercial customer. We assume this should lead to somewhat cautious FY 2024 Falcon delivery guidance. The situation looks a bit better at Gulfstream, Cessna and Bombardier (slight delivery increase y-y), although the trading environment of the business jets industry remains uncertain.
RR/ SAF SAF AM AM AIR AIR MTX
Airbus headed for a slight beat to its delivery forecast We expect 112 civil aircraft deliveries for Airbus in December, which would bring the company''s FY performance to 735 units delivered in 2023, slightly ahead of guidance at around 720 units and consensus at 723. This solid year-end delivery performance comes after progressive improvement in the perception of execution risk throughout Q4, parallel to a cautious return of optimism about the ability of Airbus suppliers to deliver on their recovery plans. This recovery should include a strong showing for A320 family aircraft deliveries (86 units in December, up 10 y-y), with a good share of deliveries powered by CFM Leap-1A engines. All things being equal, the beat to consensus deliveries could hint at a possible beat to consensus of EUR140m-200m on EBIT and a more material EUR350m-450m beat on FCF through WC release. Boeing - solid deliveries, production system remains under scrutiny Boeing released its December deliveries yesterday, with 528 units over the full year (up from 480 in 2022), in line with its target. Boeing delivered 396 737s over the year, meeting its revised goal of 375-400 single-aisle planes, which had been trimmed from an initial target of 400 to 450 jets. Market focus, however, remains on the group''s production quality issue, with an ongoing grounding of the 737MAX9 fleet, which in our view has only marginal impact on our stocks under coverage. Dassault Aviation - delivery target miss ahead, but the focus is elsewhere The conjunction of an uncertain economic environment, delayed entry into service of the Falcon 6X (only one aircraft delivered this year according to Cirium database), and especially persisting supply chain issues have clearly weighed on the civil aircraft delivery capability of Dassault Aviation, which we see delivering only 25 Falcon jets this year, well short of a 35-unit target. Despite this volume drag, we only expect a moderate drag on FY profits due to...
Rolls-Royce^ (RR, Buy at 263p) - Capital Markets Day, material upgrades
A highly expected communication event Rolls-Royce held a crucial investor day, representing a turning point in the group''s history, as it is entering a new phase of performance development. The direction of the strategy confirmed the main insights shared so far: a focus on optimizing the returns at businesses where Rolls has the strongest competitive advantage (Trent and Pearl engine families, Transport, Combat, Subs, etc.), mostly through better leverage of pricing power, efforts to optimize the durability of products in service and cost reduction, and a reduction of exposure (RandD cuts, divestments, partnering strategies) elsewhere, including the exit of Rolls-Royce Electrical. 2027 targets beat consensus, mostly on cash Rolls-Royce chose to formulate its ambition via a set of targets for 2027 (group EBIT at GBP2.5-2.8bn, FCF at 2.8-3.1bn), underpinned by divisional margin ranges and a few operating metrics (flight hours, engine deliveries at 300-350, 1,100-1,200 shop visits including 700-750 major refurbishments, 40% time on wing increase for civil engines). While the bottom of the EBIT range is in line with consensus, the bottom of the FCF range beat expectations by 25% (Visible Alpha), reflecting a jump in LTSA advances (GBP0.8-1.2bn annual tailwind, vs GBP0.5bn guided at previous CMD) as Rolls expects engine flight hours to continue to grow and support costs to be contained. Now for the delivery: a few milestones lacking to track annual progress on execution After a significant rally year to date, we think that the Rolls-Royce share yields small upside based on our prudent methodology (forecast increased to the bottom of the 2027 target ranges, 2025-based SoP, yielding a TP upped to 285p). The choice of a high-level message by Rolls has a drawback in our view: the lack of detailed graphs quantifying the annual impact of specific drivers over the coming years will make the tracking of its execution complex. We think it could take some time...
Rolls-Royce^ (RR, Hold (from Buy) at 245p) - Travelled and arrived - hold for now
Rolls-Royce Holdings plc SDX Energy PLC
Airbus Q3 deliveries expected at 172 aircraft At Airbus we expect 55 deliveries during the month of September, composed of 4 A220s, 45 A320s (24 A320 and 21 A321), 2 A330neos and 4 A350s. This is only 3 aircraft higher than the previous month, meaning we do not anticipate the usual end of quarter delivery spike. This would bring Q3 deliveries to 172, vs 140 deliveries in Q3 22. As we enter the final quarter of deliveries, the market will return to closely tracking delivery levels to monitor the company''s likeliness to hit or beat its FY delivery target of 720 aircraft. To do so, Airbus needs to deliver 232 aircraft, vs 226 aircraft in Q4 22. We expect the company to reiterate its FY delivery target with its Q3 release. Airbus civil aircraft EBIT seen at EUR1.1bn in Q3 We expect Q3 EBIT adjusted of c.EUR1.1bn at Airbus'' civil aircraft business, up c.EUR500m y-o-y. This should reflect a 23% increase in deliveries with a positive mix, EUR125m tailwind from favourable FX (4 cents improvement in the hedge rate) and EUR50m tailwind from fixed cost absorption (net of cost inflation). Investors'' focus should remain on the progress of Airbus key suppliers on their recovery plan, especially large US Tier 1s, with PandW''s ramp-up ability now sitting at the top of investors'' concern. Lacklustre deliveries at Boeing, at 105 in Q3 We expect 27 deliveries at Boeing, a 24 unit drop from September 2022, weighed down by low deliveries of the 737MAX (15 deliveries expected in the month of September vs an average of low 30s so far in 2023). This would bring Q3 deliveries at 105 aircraft, versus 112 in Q3 2022. This can be explained by the recent supplier and logistical issues experience at Boeing. Nonetheless, the company has maintained its 2023 delivery guidance at 400-450 units for the 737MAX, meaning the company must deliver 120-170 737MAXs versus 107 units in Q4 2022. However, management added the caveat this will most likely land in the bottom end of the range....
August deliveries at 50 aircraft at Airbus, 33 at Boeing At Airbus we expect 50 deliveries during the month of August, comprising 6 A220s, 41 A320neos (17 A320 and 24 A321), 1 A330neo and 2 A350s, up 11 aircraft vs August 2022. Our usual methodology gives us a range of 45-50 aircraft. Note that August deliveries are usually lower versus the rest of the year, but we nonetheless expect Airbus to deliver in the upper range of our estimates, demonstrating a satisfying production rate level. At Boeing we expect 33 deliveries, comprising 22 737MAXs, 3 767, 3 777 and 5 787, 2 aircraft lower than in August 2022. With no significant catalysts left for the remainder of the year given recent CMDs and the Paris Air Show before the summer, the market should return to closely tracking monthly deliveries to monitor production flows and the feasibility of hitting full-year delivery guidance targets. Slight skew to the GTF on A320 deliveries We track a slight skew to the GTF engine on A320 deliveries in August, with 48 GTF engine deliveries tracked to the programme vs 34 LEAP engines. This represents a 59%-41% share split between GTF-powered and LEAP-powered A320s, versus an average 50-50 split since the beginning of the year. This illustrates there is so far no evidence of a prioritisation of GTF deliveries to support the fleet in service and cannibalising OE deliveries, which has been a key topic of concern in the sector given recent issues around metal contamination in some cases disrupting the ramp-up capabilities of the engine makers (PW1000, concerns on the GE90). Another month of lacklustre Falcon deliveries We track 24 business jet deliveries in the month of August, bringing the ytd total to 265 deliveries versus 284 at the same time last year. We continue to track low Falcon deliveries, with only 1 delivery expected in August, bringing the ytd total delivered to 11 (versus 19 the same time last year), compared to the company''s delivery guidance of...
After years of slippage, Rolls Royce may have finally found the bottom. H1 23 was marked by a 28% organic increase in revenues, a 531bp increase in operating margin and a sharp increase in cash generation, thanks to a higher activity level and the initial benefits of the multi-year transformation plan. Following these strong results, the company has upgraded its FY23 outlook.
Detailed H1 results release confirms message of the trading update Rolls-Royce released its final H1 results, in line with its July 26 trading update, with an underlying EBIT of GBP673m (GBP660m-680m guided) against a backdrop of strong flight hours but a complex execution environment. H1 FCF was GBP356m (GBP340-360m guided) despite GBP600m inventory headwind. The results added granularity on the Civil Aerospace mix, with frontloaded spare engine deliveries (GBP100m tailwind est. in H1, which should reverse in H2), a relatively modest reduction in provisions for onerous contracts (GBP35m, a sign of slightly slow progress vs our hopes), a positive LTSA catch up of GBP70m, and a 27% increase in large engine shop visits. Model overhauled for stronger delivery of earnings and cash Our revised EPS include a full reshuffle of Civil Aerospace profits forecast factoring in price increases and cost control in line with the upgraded guidance of the trading update: 2023 underlying operating profit of GBP1.2-1.4bn (vs previous guidance of GBP0.8-1bn) and FCF guidance to GBP0.9bn-1.0bn (vs previous guidance of GBP0.6-0.7bn). We remove any dividend payment this year, as shareholder cash return will be considered only once back to investment grade. Neutral stance maintained - what we would need to turn buyers It is indisputable that the new CEO has been able to infuse a sentiment of urgency in the group that allows to impose drastic cultural changes. Early benefits are surprising on the upside but sustainable transformation will take much longer. Visibility remains limited on the group''s trading environment (power systems order, supply chain recovery) and the extent of margin improvements to come on existing long-term maintenance agreements. Based on our 2025 forecast, the company seems fairly valued. This is reflected by our upgraded TP at 196p (up 19p for stronger cash, 7p for lower time discount, the rest stemming from earnings upgrade mostly in civil...
Rolls-Royce^ (RR, Buy at 184p) - H1 results reconfirm strong performance
July deliveries at 59 aircraft at Airbus, 41 aircraft at Boeing We tracked 59 deliveries at Airbus for the month of July, comprising: 5 A220, 17 A320neo, 27 A321neo, 3 A330neo and 7 A350. We flag that our usual methodology gave us a delivery range of 47-65 deliveries. At Boeing, we expect 41 deliveries: 32 737MAX, 2 767, 3 777 and 4 787. With Airbus''s recent CMD and H1 results now behind, this leaves no significant catalysts for the remainder of the year. As such, the market should return to closely tracking monthly deliveries as a means to monitor production momentum at OEMs and to gauge any signs of improvement of the supply chain environment given recent hiccups (e.g., quality issues at Spirit AeroSystems etc). July engine deliveries in line with ytd average, questions on GTF prioritisation going forward On the engine front, we track GTF and LEAP deliveries to be more or less in line with recent months, with 64 GTF deliveries and 100 LEAP deliveries respectively versus an average ytd of 55 and 113 respectively. After a volatile few months, with suspected prioritisation of GTF production to support the fleet in service, recent data has been hinting at a stabilisation. This dynamic will, however, continue to be a key watchpoint for the market given recent issues on GTF durability, with more recently a rare condition in powdered metal used to manufacture some engine parts prompting an acceleration of 1,200 PW1100G-JM (powering the A320neo) engine shop visits. While this will be a major theme in H2, note that RTX''s management clarified on the earnings call that the current situation should not impact 2023 deliveries at Airbus given its delivery commitments to the company. Unequal delivery momentum at business jet manufacturers We continue to track low deliveries for Falcon business jets in the month of July, with only 1 delivery expected (vs 4 in July 2022), bringing the total ytd to 10 deliveries vs 19 at the same time last year. Despite...
Initial Equity Trading Comments - 28 July 2023
RR/ WIL VANQ PEBB WPP NWG PSON GNC AZN STAN MONY AGR
Rolls-Royce^ (RR, Buy at 185p) - EPS upgrades ahead of H1 results
Rolls-Royce^ (RR, Buy at 153p) - H1 update; material upgrade to guidance
Airbus Q2 deliveries expected to be up 18%, Boeing up 12% y-o-y We expect 66 deliveries at Airbus in June, marking a continuing recovery of monthly deliveries after 54 units in April and 63 in May. June deliveries should include 4 A220s, 4 A320ceos (apparently delivered from inventories to Chinese customers), 49 A320neos (with a strong share of A321s: 29 units), 2 A330neos and 7 A350s. This would bring Q2 deliveries to 183 total, up 18% vs 155 in Q2. Orders should be strong, supported by the bulk order announcements at the recent Paris Air Show. GTF-powered aircraft deliveries continue to slowly progress at 68 aircraft in June, vs 62 in May and 60 in April. At Boeing, we track 59 deliveries in June, bringing Q2 to 135 aircraft versus 121 in 2Q22. Favourable phasing effect likely could bring Airbus Q2 margin close to record levels Stars seem to be aligning for a strong Q2 at Airbus''s commercial aircraft business. With a good volume tailwind (28 aircraft), a strong mix (share of A321s), an especially favourable FX tailwind (5c. of y-y improvement in hedge rate to 1.19, vs 2c. for the FY), and even when considering a continued front-loading of RandD spending, we expect c.EUR1.7-1.8bn of potential EBIT adjusted at Airbus in Q2, which would bring the division''s margin close to the record 16.7% booked in Q2 21. Beyond, we continue to see a favourable environment supporting a durable upturn in profitability at the top of the civil aerospace value chain. Uncertain Falcon delivery environment We continue to track a soft delivery performance on the business jet front at Dassault Aviation, with only 5 deliveries expected in Q2, almost half of Q2 22 levels. Against a backdrop of slowing global order momentum in the wider business jet industry overall, a performance of 9 deliveries in H1 23, down from 15 in H1 22, would make the 35 FY Falcon deliveries target look challenging. The momentum could, however, be revived post entry into service of the Falcon...
Confirmed positive momentum at Airbus in the month of May We expect good delivery numbers at Airbus this month, reaching 60 aircraft (13 higher than in May 2022). This would make it the second highest month of deliveries, which is reassuring given the strongest month so far was in March, with only one more aircraft delivered, and which usually incorporates an end-of-quarter delivery spike. Once again, different data sources pointed to a wide range of deliveries for this month, ranging from 55 to 67. Also, after having been lacklustre since the beginning of the year, we note deliveries of the A350 are at reassuring levels, with 5 aircraft deliveries expected in May. Overall, this continues to provide evidence for positive momentum in deliveries observed since the month of April, relative to the beginning of the year. Solid order and delivery momentum continues at Boeing Despite a delivery halt of the 737MAX-8 due to a supplier defect, we track a solid level of deliveries at Boeing, at 51 aircraft (16 units higher than in May 2022). This leaves YTD deliveries up 25% versus 2022, supported by the resumption of deliveries of the 787 and improving deliveries on other programmes. This supportive momentum comes as Boeing''s CEO recently commented that the near-term focus of the company will be to restore satisfactory levels of deliveries on all programmes after recent years of turbulence. Boeing also continued its strong momentum on the order front in the month of May, after Ryanair placed an order for 300 737MAXs (150 firm and 150 options). Satisfactory engine delivery levels on the GTF and LEAP We note May will be another month of good GTF deliveries for the A320 programme, at 52 engines (vs 26 in May 22), a continuation of April levels after a few months of low deliveries. We see this as a possible reprioritisation of OE deliveries of PW1000 after a few months of focus on the support of the fleet in service. On the LEAP, after a month of low...
Rolls-Royce^ (RR, Buy at 156p) - Trading update; expectations unchanged
Positive momentum in deliveries at Airbus continues but questions remain unanswered on the A350 At Airbus we track 54 deliveries in the month of April (6 higher than in April 2022), although we caveat that different data sources point to a wide range of deliveries this month, from 41 to 61 aircraft. We particularly note a strong delivery level of A321s vs A320s at 30 and 13 deliveries respectively. Although April deliveries will be lower than March (61 aircraft) this shows a continued positive momentum relative to the beginning of the year, but we believe it is too soon to talk of an inflexion, especially as A350 deliveries remains a key watchpoint. A350 deliveries have been lacklustre so far this year, with April set to be no different at 3 deliveries expected, bringing ytd deliveries at only 8 aircraft vs 21 over the same period last year. We view this as a key element of clarification the company will have to provide in upcoming communications. 737MAX delivery weighs on Boeing April deliveries At Boeing we expect a low level of deliveries in April, at 21 aircraft, weighed down by the current 737MAX delivery pause (13 aircraft expected vs 28 in April 2022). Reminder that Boeing announced on April 13th that deliveries of the 737 Max-8 aircraft would have to be halted due to a manufacturing defect from its aerostructure supplier Spirit. The manufacturing error would concern quality issues on the fuselage section made by Spirit Aerosystems, with a ''non-standard'' process used for the installation of two fittings in the aft fuselage. 737 Max-9 deliveries are unaffected. 787 deliveries are holding up at 6 aircraft tracked for April. Unequal engine deliveries for the month of April At MTU, we note a strong level of GTFs delivered for the A320 programme, at 54 engines vs 34 in April 2022, the highest level so far this year. This follows a few months of low deliveries to the programme, suggesting MTU was prioritising spare engines to support its...
Airbus March delivery rebound - strong start of the year for Boeing After a weak January and a lacklustre February, we expect a rebound of Airbus deliveries to 62 in March (just one aircraft down y-o-y), bringing Q1 deliveries to 129 aircrafts, versus 142 in Q1 2022. The y-o-y drop mainly stems from the A350 (down 11 units y-o-y in Q1), with just one less A320 y-o-y. This is overall a positive signal of normalising execution on the A320 production in line with what we see as an ongoing derisking of A320 assembly at Airbus. At Boeing, the continued 737MAX delivery momentum and resuming 787 deliveries support a 22-unit increase in March 2023 to 63 units. This should bring Boeing''s Q1 deliveries up 36% y-o-y at 129 units. Airbus Q1 EBIT under pressure from FX and deliveries phasing - focus should be elsewhere We expect Q1 EBIT adjusted of c.EUR800m at Airbus''s civil aircraft business, down c.EUR250-300m y-o-y. This should reflect a 9% decrease in y-o-y deliveries, unfavourable quarterly phasing of hedge rates (3 cents y-o-y deterioration of hedge rate in Q1, turning to a tailwind from Q2), and the non-recurrence of two effects impacting Q1 22: a EUR350m tailwind from a labour agreement at group level and a EUR200m charge related to Ukraine. Other effects are so far expected to be marginal. Investor focus on Airbus''s Q1 reporting is likely to be on the quality of execution, and the ability to contain cost overruns and inflation while restoring control over the supply chain. A contrasted start of the year for engine makers We track 384 installed engine deliveries in Q1 at Safran representing a 58-unit improvement y-o-y, with a continued skew towards the 737MAX (64% of LEAP deliveries). At MTU we track 146 deliveries, up 34 units y-o-y, most notably with a 20-unit improvement in GEnX deliveries. GTF-powered aircraft deliveries in March disappoint (series engines down 4 units y-o-y), which may be seen as a signal of PandW''s needs to reprioritize spare...
Still no stellar delivery levels in February At Airbus we track 39 deliveries in February, made of: 3 A220s, 9 A320s, 23 A321s, 2 A330s and 2 A350s. We point to a particularly high mix of A321 deliveries this month. While this is an improvement from the 20 deliveries of January, this compares to 49 deliveries in February 2022 and continues to be at low levels in the grand scheme of things. Following the guidance set at 720 aircraft deliveries during full year results two weeks ago, the bar is set low for 2023 (59 units increment y-y), which will continue to have a backloaded delivery profile in our view. We take a deeper dive on this topic and implications in our latest note: AIRBUS (+) : Completing the clean-up (25). At Boeing, we track 27 deliveries (24 737MAX, 1 747, 1 777 and 1 787) versus 22 last year. MTU deliveries continue their upbeat track We identify 80 LEAP deliveries in February (vs 92 last year), with a continuing skew to the 737Max versus the A320 (32 and 48 respectively) albeit lower than the 54-engine gap between both programmes observed in January. We however continue to note a strong level of engine deliveries MTU is exposed to in February, with 40 GTF deliveries (vs 30 last year) and 46 total across all programmes (versus 34 last year). On the other hand, Rolls-Royce deliveries continue to lag with only 8 identified deliveries (2 Trent 700, 4 XWB and 2 Trent 7000) versus 18 last year. Slow take off in 2023 for business jets deliveries Concerning business jets, we identify 12 total deliveries in February: 2 Bombardier, 3 Cessna, 1 Embraer, 4 Gulfstream and 2 Falcon, versus 22 deliveries last year. This represents a slight improvement from January levels (only 8 total deliveries) but is well below the average monthly level of deliveries in the high 30s observed in 2022. Albeit we recognise the first two months of the year are usually the lowest months for business jet deliveries, so far January and February levels have...
We were wrong to assume that the new CEO’s task to transform the group will become tougher as cost of refinancing debt increases. Judging by the share price reaction to Thursday’s beat and 2023 guidance for £0.6-0.8bn FCF, any pressure to make strategic changes has eased. Why temper with a business model that generated over £1.1bn of annualised FCF in H2/22 on a market cap of £11bn with engine flying hours (EFH) at c70% of 2019 levels. At this rate, the company could be net cash neutral by 2025. However, we cannot ignore the asymmetry in the business model, which in 2020-21 lost more cash from a single event than it generated in over five years of normal trading previously. Without a crystal ball, the only way we can account for this risk is by continuing to use a high WACC of 9.5% in our DCF model. This is the reason why despite the upgrade to our FCF forecasts, our DCF model only produces a TP of 92p. Hence, we maintain our SELL recommendation.
Rolls Royce gained as much as 24% today, on the back of the earnings beat and renewed hope for a bright future following the new CEO’s ongoing transformation review. Pre-tax profit of £206m was double the market’s expectations and FCF improved by £2bn. FY22 adjusted income and FY23 guided operating profit are in line with our estimates and, hence, we will not make any significant changes to our current target price.
A weak month for deliveries at Airbus, a strong start to the year for Boeing In January, we identified 20 deliveries at Airbus (1 A220, 17 A320, 1 A330 and 1 A350), versus 30 aircraft in January last year. As flagged in our recent sector outlook note: AEROSPACE and DEFENCE: Flight 2023, we expect 2023 to be another backloaded year for deliveries at Airbus, with low monthly delivery prints in the near term fostering a difficult momentum environment for the share price. On the other hand, we note a strong start to the year at Boeing, for which we identify 39 deliveries in January (35 737Maxs, 1 747 and 3 787s), versus 32 last year. LEAP deliveries heavily skewed to Boeing, improvements in GTF, Rolls-Royce still lagging We identified 86 LEAP deliveries in January (vs 88 last year) but note a heavy skew to the 737MAX, with 70 engines delivered versus only 16 for the A320 (this compares to 54 for the Max and 34 for the A320 last January). We also identify 28 deliveries of the GTF in January, versus 18 last January. Combined with the pickup in GEnX deliveries observed since October, we note a 20-engine improvement y-o-y for deliveries at MTU. This is line with the message from the company on improvements on the OE deliveries front since the difficulties encountered early 2022. On the other hand, engine deliveries continue to be depressed at Rolls-Royce, for which we saw only 4 deliveries in January (2 Trent XWB and 2 Trent 7000), versus 8 last January. All eyes on China''s reopening for engine makers The recent reopening of China and lifting of quarantine rules for travel will be a positive tailwind for names most exposed to international travel, namely Rolls-Royce. This will bring a positive boost to its engine flight hours, with traffic in and to and from the region representing 25% of the base in 2019. This will also be a tailwind for MTU (17% exposure to China in V2500''s current in service fleet) and Safran (16% exposure for the CFM56), as this...
We think Rolls-Royce (RR) is primed for recovery. As debt is paid down and efficiencies are realised, we see much-improved returns on capital, translating into FY25F EPS of 7.6p and a growing dividend. We also note the potential for value creation in New Markets, leveraging the momentum of recovery, back to growth. We view RR as a compelling recovery play with robust end-markets. We initiate coverage with a 12-month fair value estimate of 130p (24% upside potential) and a BUY recommendation.
Airbus final delivery sprint may well fall short of expectations We forecast Airbus deliveries to be in a range of 91-98 aircraft in December. Given Airbus'' history of beating December estimates in a final delivery rush, we settled for 98 (vs 93 in Dec 2021). This would imply 663 deliveries for FY 2022 (vs 611 in 2021). As a reminder, Airbus warned on December 6 its target of around 700 deliveries for 2022 was now out of reach. FY consensus deliveries was subsequently trimmed to 683. 663 units would therefore still be a disappointment, reflecting continued supply challenges that now go well beyond just engine shipment delays, and seem to spread across the product range. Probably not the final negative catalyst for Airbus It is unclear whether such low deliveries would come as a disappointment to Airbus, which only stated that the deliveries guidance would not be missed by a significant margin back in December. The question is whether there is new risk to the EBIT and FCF guidance for 2022, both reiterated at the time of the deliveries warning. Our stance remains that the EBIT risk for 2022 is limited, especially considering positive FX in Q4, and is more material on the cash side. Another debate is whether low 2022 deliveries bode for higher supply chain difficulties and consensus deliveries cuts in 2023, with a backloaded delivery profile, or whether this should imply stronger inventory release later in the year. We assume investors will take a cautious stance into FY results and the release of 2023 guidance, feeding a sideways momentum of the share in the near future. Boeing ends the year on a high note, Falcon deliveries more at risk We expect a continued rebound of Boeing deliveries, with 64 aircraft in December (vs 38 in Dec 2021), the highest level since Dec 2018, supported by the 737MAX and 787, bringing the FY to 475 (vs 340 in 2021). We expect FY 737MAX deliveries at 370, close to the 375 guidance. The strong MAX momentum and...
Acceleration of deliveries continues at Airbus, but the pace remains underwhelming We expect 62 aircraft deliveries at Airbus in November (up from 60 in October, 55 in September), to be compared with press estimates ranging from 55 to 65 units. This would include 6 A220s, 49 A320-family aircraft (of which 25 A321neos) and 7 widebody aircraft (4 A350s, 3 A330s). Our 62-unit estimate would leave 141 aircraft to be delivered in December to meet FY guidance of 700 units. This compares to the historical record of 138 deliveries reached in December 2019. Debates rise on possible rates adjustments at Airbus While all missing parts supporting Airbus'' FY guidance reached inventories in October (Q3 results comment), the 700-unit target remains challenging, given CEO statements this week that completing aircraft in production is proving more complex than expected. We see rising chances of an unusual guidance update with Airbus November deliveries (usually between the 7th and the 10th of the following month). We already stand c.10 units below FY target, mostly due to slow A220 ramp vs plan. We see the possibility of an additional miss by up to 20 aircraft should execution difficulties continue. The debate should then be whether Airbus can maintain its profit guidance (possible, especially if the shortfall partly stems from the dilutive A220) and cash guidance (more challenging). Risk persists on 2023 trajectory as well, maintaining negative momentum on the share. We don''t expect any comment on 2023 deliveries before at least early next year. Deliveries catch up continues at Boeing, Dassault''s FY guidance in sight We expect 42 deliveries at Boeing in November (32 737s, 10 WBs), bringing ytd deliveries to 405, leaving 58 deliveries in December to meet consensus of 463 aircraft (vs 38 in Dec 2021). We expect 1 Falcon delivery in November. With 9 left to be delivered, this leaves Dassault''s FY guidance of 35 within reach in our view, given its usual...
RR/ SAF SAF AIR AIR MTX
Airbus begins its final quarter delivery sprint at 62 aircraft expected in October... We expect an acceleration of deliveries at Airbus in the month of October, at 62 aircraft (51 A320neos, 4 A220s, 2 A330neos and 5 A350s), making it the second highest month of the year for deliveries (behind March at 63 aircraft). We highlight however that A220 deliveries continue to remain at depressed levels with only 38 delivered ytd, which we consider as being behind schedule. With Airbus having reiterated its FY22 delivery target of 700 aircraft during Q3 results last week, this leaves 201 aircraft left to be delivered for the remaining two months of the year, versus 151 in Nov-Dec 2021. Management brought reassurance on the matter, stating the equipment for the final deliveries were at pre-FAL or FAL stage, reducing Airbus'' dependencies on on-time deliveries from suppliers to meet its target. ...supported by strong levels of first flights and LEAP-powered deliveries for the A320 family Concerning the A320, we note a strong level of LEAP-powered aircraft delivered in October, at 29 units, versus the 2022 average of 22, and note a continued acceleration of LEAP-powered first flights, at 28. This continues the trend observed since September whereby LEAP-powered first flights returned to, and even slightly surpassed, the beginning-of-the-year levels of mid 20s, after a pullback over the summer. We also note a catchup in GTF-powered first flights, at 21 in October, versus the mid-teens level observed in recent months. This follows comments made by engine makers during Q3 results last week that improvements were being noticed on the challenges facing OE deliveries. Weaker deliveries expected at Boeing On the other hand, we expect 34 aircraft deliveries at Boeing in October (24 737, 1 747, 2 767,1 777 and 6 787), reflecting the usual cyclicality noted at Boeing this year whereby the first month of the quarter is at lower levels versus other months. This...
Airbus Q3 deliveries expected up marginally y-y at 141 units We expect a small acceleration of deliveries for the month of September at 56, vs 39 in July and 46 in August. This should partly reflect the ongoing process of clearing of the inventory of ''gliders'' mentioned by the Airbus CEO during the group''s recent CMD. The 56 aircraft we expect to have been delivered would include 3 A220, 23 A320, 21 A321, 5 A330 and 4 A350. This would bring Airbus Q3 deliveries to 141, a 14 unit increase y-y and 14 unit decrease vs Q2 2022. This would imply 262 deliveries in Q4 22 (vs 187 in Q4 2021) to meet Airbus FY target of 700. We note an acceleration in the first flight activities in Sept. (A320s powered by Leap especially), in line with that trend. We expect the FY delivery target of Airbus to be reiterated with its Q3 release. Airbus EBIT to reflect positive volume and mix, but also cost ramp up The 14 increase in deliveries should support small EBIT growth at Airbus commercial aircraft in Q3. We expect at this stage c.EUR160m of increase in civil aircraft EBIT in Q3 to c.EUR600m. This should reflect the higher volume and positive mix (5 fewer A220s, 12 more A321s, 11 more wide bodies). FX impact should be neutral on EBIT this quarter (stable hedge rate at 1.23). We also assume that RandD, costs phasing and the non-recurrence of 2021 provision release will weigh on Airbus Q3 EBIT by a low 3-digit number. This should mean a rather soft margin in Q3 ahead of a volume-driven recovery in Q4. Strong deliveries at Boeing driven by the 737MAX Q3 represented a strong quarter of OE deliveries for engine makers. Deliveries of aircraft powered by Rolls-Royce engines more than doubled in Q3 y-y. Deliveries of aircraft powered by Safran engines were up +20% y-y (+3% at MTU). It reflected strong 737MAX deliveries (91 deliveries in Q3, up 29 units y-y). Note however that Boeing delivered some new-build aircraft with engines from existing aircraft in storage. Commercial...
Soft August deliveries expected at Airbus and Boeing We expect August deliveries at Airbus to be the at the usual depressed level versus other months, with our methodology landing in the range of 32-41 aircraft. We nonetheless expect Airbus to deliver at the top end of this range at 39 aircraft in August, one lower than in August 2021, composed of 2 A220, 1 A319neo, 17 A320neo, 13 A321neo, 2 A330neo and 4 A350. At Boeing we expect 41 deliveries, made of 1 737, 31 737MAXs, 2 767s, 3 777s and 4 787s, up 19 aircraft versus August 2021. Engine makers driving delays While the majority of the AandD supply chain is under pressure, the stand-out culprits behind these depressed delivery levels are engine makers. We expect the debate to remain focused on industrial execution for the remainder of the year, with particular focus on engine makers'' ability to catch up on the delays accumulated in deliveries to the OEMs. Indeed, recent comments made in the press by management hint these delays will persist until early 2023, with sources reporting in the month of August that Boeing even resorted to fitting engines from stored 737MAXs onto new aircraft at FALs. The return of widebody interest As Covid-restrictions continue to ease in China and international borders reopen in Asia (e.g. Singapore) and as cargo activity picks up, the interest in widebody aircraft has re-emerged. At Airbus, Malaysia Airlines placed an order for 10 A330neo (10 others to be leased from AerCap) and Etihad Airways firmed up an order for 7 A350Fs. At Boeing, UPS placed an order for 8 767s. All eyes on Airbus'' CMD Airbus will hold a CMD on the 23rd of September, where further visibility should be given be on the long-term dynamics of the civil aero business, alongside consideration on ESG matters.
RR/ SAF AIR MTX AIR 0IU8
Rolls Royce published mixed figures. Profitability was particularly low, pushing the net result back into the red zone. However, FCF generation was a positive surprise despite the rise in inventory. It has finally found an agreement to sell ITP Aero and will use the resulting cash to repay its only floating interest rate debt.
Investor worries go beyond the earnings miss Rolls-Royce''s share has been under significant pressure after a release that missed consensus earnings forecast but provided a significant beat on cash flow. Beyond earnings, we think that the share price reaction probably crystallized two issues prompting investors to wait on the sidelines: management transition, and persistent short-term volume uncertainty. One-off disclosures, and impacts on perception of accounting risk at times of CEO change A year after a CFO change, and six months ahead of CEO replacement, Rolls-Royce disclosed two one-off tailwinds that supported its H1 21 results: a GBP270m FX revaluation credit in Civil Aero (not mentioned last year, partly reversing in H2 21), and a GBP45m one-off spare parts sales boost in Defence (mentioned but not quantified last year). Any top management change can involve new assumptions about future costs, thus resetting expectations. Rolls-Royce is known for its complex business model and accounting, which implies some management judgement calls. The recent incremental disclosure has thus acted as a signal that the CEO change could involve some risk. A trading momentum issue Consensus EBIT for 2022 (based on Visible Alpha data) stands at GBP517m, vs a guidance implying c.425-430m. Rolls'' target remains based on an acceleration of engine shop visits (milestone for aftermarket revenue recognition) that can look a bit challenging: Rolls recorded 477 shop visits in H1 and targets a 1,100-1,200 range FY. The 40% increase in shop visits in H2 vs H1, supported by flight hours recovery may well be achievable, but it is not fully derisked; we see significant risk of consensus cuts post this release. Underperform stance reiterated Progressive air travel recovery, FX support and relatively attractive valuation drive compelling equity stories in civil aerospace. Within the segment, we continue to believe that Rolls-Royce, despite a rather attractive mid-term...
Airbus Q2 deliveries expected to be marginally up vs Q1 2022 While orders continue to be supportive of a sustainable production upturn (watch the 292 A320 orders from China last Friday, and a likely inflow at the Farnborough airshow from July 18), debates remain focused on execution and industrial efficiency in the ramp-up. We forecast 49 deliveries in June at Airbus within an unusually wide range of 41-54 (due to a strong delivery rush noted at the end of June): 5 A220, 40 A320 family (1 A319neo, 15 A320neo, 24 A321neo) and 4 A350. This should bring Q2 deliveries to 144, a 28-unit drop y-y and 2 units higher than Q1 22 (before A350 adjustment for Russia). Slow deliveries ytd, constrained by supplies, have raised fears of a miss to the 720 delivery guidance. Historical analysis stresses, however, that this pattern is not unusual for Airbus (ability to cope with late surge in engine suppliers, backloading of deliveries to Asia-Pacific) and its target remains within reach if supply constraints ease in H2. EBIT adjusted expected at EUR1.1-1.2bn in Q2 We don''t expect a repeat of the strong margin of Q2 21, when efficiency of production is estimated to have been at its peak. We forecast civil aircraft profitability to be marginally down from Q1, based on comparable deliveries. This should reflect 5c. of deterioration of the achieved hedge rate y-y, a slight pick-up in RandD spending, continuing delivery of costs savings and a positive A320 delivery mix. We also assume that Airbus might book c. EUR200m of charges for a deteriorating trading environment (Russia-Ukraine crisis, cost inflation), a level similar to the headwind seen in Q1. This in our view should drive a reiteration of the FY EBIT guidance. Beyond that, the impact of supply chain difficulties on industrial efficiency will be one of the big question marks in the quarter. Strong Boeing deliveries driven by the MAX We expect a solid delivery quarter at Boeing, driven by the Max, with 54...
Deliveries to Chinese customers remain a key point of focus In recent months we have seen an acceleration of ''e-deliveries'' to Chinese customers in light of the country''s zero-Covid strategy. Airbus conducting customer acceptance flights on behalf or airlines, with the aircraft then stored until the staff can come and retrieve it. Whilst this does not impact the planned delivery schedule and Airbus'' financials, it does however make the number of deliveries more complex to track (hence the beat of Airbus deliveries vs our forecast over the past two months). We have therefore adjusted our methodology to better capture this phenomenon. The question then remains how long this situation will carry on, and if prolonged lockdowns in China may drive a reshuffling of the delivery schedule. However, with the recent trajectory of loosening of restrictions in China, we do not expect this to represent an issue at this stage. 48 deliveries expected at Airbus in May, 37 at Boeing We expect Airbus to have delivered 48 aircraft in May, with a pretty strong mix overall: 4 A220, 18 A320neo, 21 A321neo (including 5 to Chinese airlines), 3 A330neo and 2 A350. This represents 15 aircraft less than the highs of March (63 aircraft) but is in line with February and April (49 and 48 respectively). For the A320 family it still implies deliveries below the theoretical assembly rate (probably around 52-53/m in our view), and therefore continuing small inventory build-up (or lower than expected assembly). At Boeing we expect the 737MAX delivery momentum to continue, with 37 total aircraft deliveries, up 2 units from the previous month and 20 units from May 2021, of which: 1 737, 31 737Max, 1 747, 1 767, 3 777 (787 deliveries still interrupted). ...but orders have been strong at both Airbus and Boeing At Airbus, Qantas confirmed its order for 52 aircraft, of which 20 A321XLR, 20 A220 and 12 A350 (this one won as part of Project Sunrise back in 2019, but only confirmed...
A useful focus on Civil Aerospace On Friday, Rolls-Royce held an event dedicated to the industrial transformation of and prospects for Civil Aerospace. It included significant granularity on the drivers of the new mid-term financial targets provided for the unit the day before. We also welcome the detailed catch-up on accounting. Some questions remain unanswered Rolls-Royce is hopeful that its efforts to maximize engine time on wing will support a civil aero margin hike to high single digit. Beyond the limited predictability of Rolls'' business model (sensitive to flight hours, shop visit timing and cost, aircraft OE rates, spare engine deliveries, FX), we remain cautious on the risk of sustained cost inflation. While we understand that supply contracts and escalation clauses offer relatively good protection near term, the exceptional increase of raw mats, labour and energy prices seems bound to weigh on the margin uplift over time, as we see at most AandD players. Earnings fully rebuilt for new portfolio and new outlook We have fully revisited our model, including the creation of the New Markets division (Small Nuclear Reactors + Electrical Propulsion) and the deconsolidation of ITP (which impacts our 2023 EBITA forecast by c.10%) ahead of the closing of the divestment. Our forecast for civil aviation has been reassessed based on Rolls'' new mid-term ambition. We have also shifted our pivot year for our SOTP to 2025, in order to better capture the mid-term targets provided by the company. This partly offsets the negative impact on our valuation of our earnings cuts. Still happy to wait on the sidelines until transition is complete Rolls-Royce''s business model is transitioning towards a refocused portfolio, trimmed of non-core activities, a more balanced portfolio exploring opportunities from alternate power solutions, but with its civil aerospace business hurt by a depressed long-haul passenger traffic, which may be the last civil market to...
Airbus deliveries pull back from March highs, MAX momentum supports Boeing We expect Airbus deliveries to pull back from March highs to a still decent 42 aircraft, down 3 units versus April 2021 (2 fewer widebodies and 1 fewer narrowbody). In detail, we expect Airbus to have delivered 5 A220, 14 A320neo, 17 A321neo, 1 A330neo and 5 A350. We note there continues to be a debate on deliveries to Chinese customers, with the country''s zero-Covid strategy leading to electronic deliveries that are more difficult to trace. We expect a good level of deliveries for Boeing with 36 aircraft deliveries, more than double last April''s figure, driven by good momentum on the Max with 30 737Max (vs 4 in April 21), one 737, one 747, one 767 and three 777, despite 787 deliveries remain suspended. Limited impact on volumes despite China zero-Covid strategy We expect the strong order momentum to continue both at Airbus, supported by BOC Aviation''s order for 80 aircraft (10 A321XLR, 50 A321neo and 20 A320neo) in April and at Boeing with Air Lease Corporation''s 32 737Max order, despite China''s zero-covid strategy weighing on traffic. Latest statistics for April show the number of commercial flights globally, which amounted to 84% of 2019 level on average in Q1, pulled back to 78-80% towards the middle of the month but have bounced back to 82% in recent days. We expect this to have no sustainable impact on the multi-year demand for new aircraft. Airbus reiterates FY22 delivery guidance and provides 2025 rate Airbus provided updated numbers during Q1 results on ramp-up plans to 75 in 2025 and reaffirmed its previous indication of 65 by mid-2023. With this new welcomed visibility, we believe the debate will shift from disruptions on execution, safeguarded by adequate buffers, to cost inflation challenges and repercussions on margins. Opening additional slots able to charge at higher prices amidst strong demand will give Airbus breathing room, but we do not rule...
Airbus Q1 deliveries seen up 4 units y-o-y, with 54 deliveries in March We expect deliveries of 54 aircraft in March, down from 72 in March 2021: 3 A220, 43 A320neo family aircraft, 2 A330neo and 6 A350. This should bring Q1 deliveries to 130 aircraft, up 5 units y-o-y. Over the quarter, the five units increase is a mix of 10 more widebodies (mostly A350s) and five narrowbody aircraft less (three A220s and two A320s less). We note that the narrowbody mix y-o-y is much more skewed to the A321neo (56% vs 44% in Q1 2021). Beyond deliveries, the focus should be this quarter on the efficiency of production and the ability to contain cost inflation. Airbus Q1 EBIT seen slightly down at Civil aircraft We expect c.EUR400m of Q1 EBIT adjusted at Airbus civil aircraft business, down c.EUR120m y-o-y. This should reflect slightly higher deliveries (program contribution up c.EUR130m), offset by an unfavourable quarterly phasing of hedge rates in 2022 (8 cents y-y deterioration of hedge rate in Q1 at 1.24) and an increase in discretionary spending costs (RandD, DDMS, ramp up costs) partially offset by better fixed costs absorption as production work continues to ramp. While pressure is looming from cost inflation, the impact should be in our view negligible in Q1. Uptick in Boeing deliveries for March closing the quarter at +26% y-o-y At Boeing, the positive 737MAX delivery momentum continues, with 43 total aircraft deliveries expected in March (vs 29 in March 2021), of which 38 737MAX (19 in March 2021). Other deliveries include 1 737 NG, 3 767, 1 777 and no 787. This should bring Q1 deliveries to 97 units (of which 85 737MAX), up 20 units y-y. Small order tally expected this month, watch for possible Russian orders restatement We expect 26 gross orders booked by Boeing in March - composed of 20 737 MAX jets for Arajet and 6 777 Freighters for DHL Express. Airbus received in March an order for six A321XLR aircraft from Air Canada, bringing total gross...
Stable deliveries yoy now enough to reach Airbus'' FY guidance Airbus deliveries should start accelerating in February after a slow start. We expect Airbus to deliver 43 aircraft, up 34% y-o-y: 2 A220, 33 A320neo family aircraft (2 A319, 10 A320, 21 A321), 2 A330 (1 ceo/1 neo), and 6 A350. While deliveries remain below production (with A320 completion rate probably closer to 45 vs 33 delivered), we would see this as a normal pattern of acceleration for a usually backloaded activity. No impact from the Ukraine crisis should be visible, with deliveries to Russian airlines (A350s to Aeroflot) still allowed over the month. Slow performance at Boeing in Feb At Boeing, we forecast 27 deliveries in February: 22 737s, one 767, two 777, and still no 787s as deliveries on the program remain halted. We still hope for resumption of 787 deliveries, although the exact timing remains hard to predict, and the cancelation of the certification authority delegation on completed aircraft by the FAA may slow down the pace of deliveries when they re-start. Orders tally in favour of Airbus this month - no impact seen on orders from Ukraine crisis We expect 78 new orders booked by Airbus in February - 30 A220s for JetBlue, 20 for Aviation Capital Group and 28 A320neos for Jazeera Airways. We have not spotted orders to Boeing except for 2 777s for Western Global Airlines. We assume that there should be no cancellation from Russian airlines or lessors with Russian exposure at this stage. Overall, we assume that the repossession trend of the large number of aircraft under leasing in Russia will not impact the net order intake this year nor disrupt the delivery plans. Business jets recovering from a weak January We expect 21 business jets deliveries in Q2 (of which two from Dassault). This would be four units better than in February last year. This recovery from a slow start would bring year to date business jet deliveries to 29, down three units from the first two...
The last time the Board searched for a new CEO it chose one of its own following “an extensive international search”. We can only hope that the “open and transparent” process on this occasion will appoint a candidate, UK or non-UK citizen, capable of addressing the fundamental problem – the asymmetric Civil Aerospace business model which barely covers the cost of capital in incident-free years but amasses heavy losses quickly. This skewness is the source of all other issues, such as the opacity of accounts that continues to vex investors and other sell-side analysts. On the assumption that disposals help to reduce net debt by £1.6bn in 2022, our DCF model, based on unchanged WACC of 7% and terminal growth of 2%, now generates a TP of 92p (52p). We, therefore, move our recommendation from SELL to HOLD.
Although RR has returned to growth in FY21, both sales and profitability have been disappointing. The resignation of Warren East after eight years as CEO will not help the stock, which saw its stock price fall as much as 18% today. The inflation in raw material and energy prices linked to Putin’s declaration of war won’t make the recovery of RR in FY22 any easier.
Strong December output should reassure on Airbus customer and suppliers management We expect strong Airbus deliveries at 93 units in December (vs 58 in November, 36 in October), supported by a long-expected inventory release finally happening. We think that this may reflect a more stringent implementation of contracts by Airbus in the back end of the year, and good supply chain control as it starts ramping production back up (from a total 56/m in Q4 est.). This should bring Airbus total deliveries to 611 for FY21 (52 A220s, 483 A320s, 18 A330s, 53 A350s, 5 A380s), close to consensus'' 608 units (we had 615) and slightly ahead of the 600 aircraft guide. Debate on Airbus is shifting to margin trajectory for 2022 and beyond The margin for error to Airbus deliveries seem to be limited now to a handful of aircraft. This may feed a solid Q4 with EUR1.4bn of EBIT expected (o/w which close to 1bn in civil aircraft), EUR140m stronger than consensus. The next focus should be the 2022 delivery target supported by further inventory release, and the A320 production ramp from 45/month in Q4 2021 to 65/month by mid-2023), and civil aircraft margin potential, which we still see approaching 14% by 2025. 737 Max recovery support Boeing and Safran OE revenues but 787 remains a drag We expect 40 deliveries at Boeing in December, bringing the FY to 342 units (up 71% y-y including 245 737MAX). This should benefit Safran (and its Leap engine deliveries), for which we see Propulsion OE sales up 26% in Q4 y-y. This contrasts with continuing OE pressure on other engine makers, including Rolls-Royce, which we see delivering at the bottom of its engine delivery target (166 large engines delivered on wing vs a guidance of 200-250 including spare engines). Business jets: soaring of the Falcon Stars seem to be aligning for Dassault Aviation. It enjoys an exceptional sales trend on the Rafale (with more orders hinted by CEO for 2022), and may beat its civil delivery...
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Rolls Royce has announced a disappointing business outlook and a mild update of its activities as of 30 November. Though it has successfully managed to cut its costs and dispose of £1.8bn of assets, its boosted FCF guidance is a one-off that will be reversed in the future. In addition, the wide-body market situation is still discouraging.
Airbus deliveries finally accelerate into year-end: 55 aircraft expected in November We expect 55 Airbus aircraft deliveries in November: 6 A220, 45 A320 (ow 44 neo), 2 A330 (both neos), 2 A350, no A380. Airbus orders will reflect a Dubai Airshow dominated by A321 demand. While the shift of the last two A380 deliveries to December is disappointing, the acceleration of total deliveries after a soft September and October is reassuring as per Airbus'' ability to limit supply chain disruptions and avoid new postponements by airlines. We estimate that Airbus probably delivered aircraft in line or marginally above production and stopped piling up new inventories this month. Reaching the FY guidance of 600 units would now require 85 deliveries in December (vs 89 in Dec. 2020), which we see as feasible against the backdrop of inventory reduction. Boeing still hurt by 787 delivery halt At Boeing, we forecast 34 deliveries during the month, supported by the continuing ramp of 737MAX deliveries (1 737 NG, 30 737 MAX expected in November) partly fed by inventory release. The widebody performance remains anaemic: a few 767s expected, and no delivery of any other type of widebody over the month. Pressure is likely to stay as the press is reporting that the return of 787 deliveries may now only happen in April 2022 as the production system remains under FAA''s scrutiny, a continuing headwind to suppliers like Leonardo or to a lesser extent Safran. Uncertainty rising into the Omicron variant spread Flight tracking stats hint at further progress of total commercial flight activity in November, with take-offs and landings now trailing 18% below 2019 levels at the end of November (still led by cargo, business jets, narrowbody traffic). While stats so far do not indicate any slowdown over the past few days caused by the Omicron variant, concerns are spreading on a reported drop in airlines bookings and new travel restrictions, which may delay the recovery....
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A relatively soft September for Airbus at 42 deliveries expected We expect a rather modest September, with 42 Airbus aircraft delivered, down from 57 last year. This rate is a bit lower than production rate, with assembly rates moving up from 47/m on all aircraft types to a total 51/m in Q3, which would imply small inventory build up, in contrast to the destocking trend expected in Q4. The 42 deliveries would include 36 narrowbodies (3 A220s, 1 A321ceo, 21 A320neos, 11 A321neos) and 6 widebodies (2 A350s, A330ceo, 3 A330neo). At Boeing, we forecast 37 deliveries in September, supported by 737MAX inventory release, offset by the continuing deliveries halt on the 787 (1 737 NG, 28 737 MAX, 3 767, 4 777, 0 787, 1 747-8). A first glance at Airbus potential Q3 performance We see Airbus Q3 deliveries at 129 units, down 16 vs the 145 of Q3 2020. We expect 18 less A320-family aircraft, with slightly favourable mix (A321s accounting for 37% of narrowbody deliveries, vs. 32% in Q3-20). Overall, we think that the headwinds from volume, FX (4c. deterioration of the hedge rate from 1.20 to 1.24), possibly recovering RandD, will be mitigated by mix, costs savings and possible net improvement in fixed costs absorption from upfront production ramp up. This may drive flattish Airbus EBIT in commercial aircraft in Q3. Given the potential for inventory release in Q4, we still see margin for upwards revision of the group''s FY guidance on deliveries (c.600 units guidance implies 136 deliveries in Q4 21, vs 159 in Q4 2020) and possibly margin (read for details AIRBUS: Margin scenarios for a cyclical recovery). Solid Q3 of OE activity for Safran, signs of positive aftermarket momentum in Q3 The aftermarket environment for engine makers remains volatile, but September seems to have shown improvements in aircraft fleet utilization vs a relatively soft August. The continuing recovery of 737MAX deliveries and an exceptional share of the Leap on September A320neo...
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B-52 engine replacement award Rolls-Royce has been awarded the engine replacement contract for the United States Air Force’s fleet of B-52H strategic bombers (a.k.a. the BUFF), beating competitors including GE and Pratt & Whitney. The award has a total potential value of $2.6bn (c£1.9bn), with an initial award of $501m (c£366m) over a six-year base period; it includes the provision of 650 engines including spares and associated support equipment and sustainment activities. Potential progress on disposals Today is the deadline set by regulators for the sale of the ITP Aero business to Bain capital. Complications to the sale arose on Spanish Government requirements for local involvement in the deal; to what extent this has been satisfactorily secured may influence the outcome today. We value ITP at £1.3bn. A successful sale would therefore represent the largest single step towards the c£2bn of disposals targeted by the group to aid in deleveraging the balance sheet towards net funds over the medium-term. The nuclear option Rolls may benefit from a change in attitude towards nuclear power at the top of Government, where there is renewed focus on energy security, a daunting net zero commitment, and a levelling up agenda to pursue. Rolls has first-mover advantage in Small Modular Reactors (SMRs), with a plan to build at least 16 plants around the UK, as part of a consortium, looking set to receive additional funding from the Government, according to the Sunday Times. Government support for SMRs is a boon for Rolls’ plan to decarbonise net aviation emissions through the use of e-fuels, which can be synthesised from green hydrogen produced via electrolysis supplied by renewables or nuclear power. Our view Shares gained last week as news of easing US travel restrictions lifted near-term prospects for Civil Aero widebody cashflows. A supportive outlook in Defence, a successful sale of ITP, and renewed interest in nuclear capabilities may provide further momentum. We place our Recommendation and TP under review (Forecasts are also under review).
40 Airbus deliveries expected in August 2021 We estimate that Airbus delivered 40 aircraft in August (+1 unit y-y): six A220, 33 A320, one A350, and no A330 or A380. The decrease from 47 units in July reflects usual normal seasonality, with August traditionally a soft month for deliveries. A320 mix remains supportive, with 50% of A321 deliveries this month. The importance of the A321 in Airbus''s success should be further highlighted by the group order intake, reflecting A321 orders from Delta (30 units) and Jet2 (36 units). Strong OE momentum for Safran, helped by the MAX Boeing deliveries are likely to remain subdued at 22 units in August, supported by the inventory release on the 737 MAX (17 deliveries of 737 MAX expected) but still with no resumption of 787 deliveries. However, combined with strong market share this month on the A320neo, the 737MAX should support strong momentum in deliveries of CFM engines ''under wing'', with total shipments at Safran expected up 74% y-y, in contrast to weaker momentum at MTU and Rolls this quarter. Airbus still well on track to beat FY delivery guidance Our August estimates imply the delivery of 216 Airbus aircraft over Sep-Dec to meet the FY guidance of 600 units, i.e., an average of 54/month vs 71/month reached over Sep-Dec 2020. To this must be added the prospects for faster A380 inventory release, as Emirates announced the accelerated delivery of its final three A380s from 2022 to October-November 2021 (a nice positive for FCF). We therefore feel very comfortable with our assumption of 626 Airbus deliveries in 2021. Traffic momentum halted by the Delta variant Despite the global roll-out of vaccination campaigns, the spread of the Delta variant has impacted global passenger traffic momentum in August and hurt the hopes of a strong Summer season. The recovery in commercial flights number has stalled, with a slight pull-back from a peak at 76% of pre-crisis levels in July to 71% in the back end of...
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H1 results have demonstrated good cost-cutting performance Rolls-Royce posted solid H1 results, with Civil jumping back into profit despite trough sales. This illustrates the early impacts of the group''s restructuring, although the performance was partly helped by a GBP160m positive LTSA retrospective adjustment. FCF performance was also a point of debate, with focus on the impact of delays on 787 concession payments. Despite a more cautious take on engine flight hours development for the year, FCF guidance was reiterated, with no material headwinds expected to spill over into 2022. Lastly, we welcome the new CFO''s diagnostic of having to deliver on: (1) the short-term restructuring promises; (2) reducing reporting complexity, although this has been a hot topic for years for the group; and (3) investing adequately in the business transition. Operating leverage set to help deliver strong margins over the longer term In this note we illustrate how cost cutting appears to have provided a massive boost to Civil performance in H1 to 10.7% true underlying gross profit (-14% in H2-20). Going forward, the volume recovery, especially in aftermarket, should enable a solid profit recovery. Over the long term, management sees Civil as able to deliver mid-teens operating profit margin, which would represent a massive increase vs. consensus expectations at 9.4% on 2025, although the volume recovery should take longer than that to yield its full operating leverage benefit. TP raised to GBp120, as we wait on some deleveraging and traffic recovery Rolls-Royce''s story remains one of de-leveraging first and foremost, which will come through the targeted disposals and returning to cash-generating mode (still expected in H2 21). H1 results were a step in the right direction but the real positive catalysts will come once the ITP disposal is complete and as flight hours recovery accelerates. We raise our EPS by 25%/4% on 2022-23, mainly reflecting a faster than...
Rolls Royce delivered surprisingly high profits in its H1 results. Though revenues are in decline and below consensus, the cost-cutting efforts implemented in FY20 are paying off, with positive operating profits whereas the market was expecting slightly negative ones. It reiterated its confidence in the mid-term recovery of its civil aviation business with tangible targets.
CEO Warren East and new CFO Panos Kakoullis delivered a confident message in their prepared remarks. While it is now clichéd to say, management are controlling the controllables. Restructuring is progressing well, which resulted in an operating profit in the first half of £307m, which compares favourably to the significant first half loss last year, and against our expectations. Sustainable cost savings of >£1.3bn are confirmed as on track for delivery by the end of 2022. While there are always a large number of moving pieces within the Rolls’ Group free cash flow number, a first half Group outflow of £1.17bn was ahead of our expectations, and with the exception of unknown timing of customer concession payments, Rolls’ cashflows should be less volatile going forward. Predictability should also be further aided by simplified reporting, albeit we note this has been an objective for some time and accounting treatments such as the LTSA creditor balances are a function of the operating model. While the timeline for a stronger recovery in large civil engine flying hours (EFH) is slipping to the right, and Rolls’ cash flow target with it, this was already priced in, given the rather bleak industry outlook for international air travel, with consensus expectations for free cash flow in 2022 already below that target level of £750m in a twelve month period when large civil EFH recover to 80% of 2019 levels, which is now expected to occur beyond calendar 2022. Recovery in domestic and business aviation markets provides encouragement that international air-travel will resume as travel restrictions are eased. However, management reinforced that returning to 2019 levels of EFH is not likely to occur until at least 2024 or 2025. Such a recovery is likewise beyond the FY24 horizon of our forecast period. Rolls’ target for at least £2bn of proceeds from its disposal programme is starting to be realised, with the sale of the marine engines business, Bergen, announced earlier this week and Rolls’ confirming yesterday that it has entered exclusive talks with a Bain-led consortium for ITP Aero, the largest piece currently on the block. This morning’s announcement also highlighted that disposal of the Civil Nuclear Instrumentation & Control business is expected later this year. Despite the UK A&D sector’s current M&A purple patch, we wouldn’t expect Rolls to play a significant role; with further non-core, relatively small, disposals as the most likely portfolio actions as the Group looks to achieve net cash and investment grade credit in the medium term.
1H21 results Rolls appears to have delivered a strong set of interim results, with revenue of £5.2bn c3% below expectations (INVe: £5.4bn) but stronger adjusted operating profit of £307m (vs company-compiled consensus of a £245m operating loss (INVe: £66m op. profit). More critically, free cash flow also appears ahead of expectations, at a £1.17bn outflow (vs cons: £1.5bn outflow, INVe £2bn outflow). In Civil Aero, large engine flying hours (EFH) were 43% of the 2019 level, as expected. The Defence business continued to perform well with H1, with growth helped by the earlier timing of spare engine and spare parts sales, which typically have been in the second half in prior years. Power Systems saw increased activity levels during the first half with improved order intake and growth in aftermarket revenue. Disposals Rolls confirmed yesterday afternoon that it has entered into exclusive discussions with a consortium led by Bain Capital on the sale of ITP Aero, with press reporting a valuation of €1.6bn (c£1.3bn), in line with our SoTP. Earlier this week the disposal of Bergen Engines was announced and this morning’s announcement highlights that the Civil Nuclear Instrumentation & Control business is expected to follow later this year. Outlook While the interim results look strong, and FY21 is on track to turn free cash flow positive in H2, the outlook highlights that free cash flow of at least £750m (pre-disposals) is achievable in a 12-month period when EFH exceeds 80% (of 2019 levels), this is now expected to occur beyond the initial expected timeframe of 2022; a development we anticipated in our sector note published last week where we reduced FY21/22E FCF estimates, but which may weigh on the shares today. Call at 0830: UK dial-in: +44 (0) 203 009 5709 , US dial-in: +1 646 787 1226 , Participant passcode: 5215 215
Airbus deliveries seen down 6% yoy following strong Q2 finish We estimate that Airbus delivered a total of 46 aircraft in July. This would be fair number following the strong performance in June but still represents a 6% yoy drop in deliveries for July. In detail, we expect the group to have delivered 5 A220, 2 A320ceo, 37 A320neo and 2 A350. The mix continued to be quite skewed to the A321, which would represent c. 45% of the A320 family deliveries vs. 33% in July last year. Boeing deliveries expected to be 29 with a more balanced customer mix Boeing deliveries continue to be weighed down by the pause in 787 deliveries but should still reach a total of 29 in July. These would be made up of 24 737 (1 NG, 23 MAX), 1 747 and 4 767. The customer split continues to normalize with the US and Europe both at c. 1/3rd of deliveries in the month, driven by deliveries to Ryanair. Deliveries to Asia remain anaemic and will likely remain so until the end of the year, at which point the 737 MAX is expected to be recertified in China. Inventories stable at Airbus, still down at Boeing due to slower first flights Despite the slightly lower deliveries, Boeing still managed to cut inventories by c. 10 aircraft this month, mainly as first flights (our proxy for production during the month) dropped on the MAX to 11 in the month, i.e. below the 16/mo nominal production rate and the 787 to 3 in the month following the announced temporary drop in 787 production from the previous 5/mo. At Airbus, we estimate a limited increase in inventories of only 2 aircraft, as first flights stood at 48 in the month. Traffic trend good as summer season seems to deliver on recovery hopes Good news appears to come from the air traffic side, as commercial flights have continued to recover in July. Based on FlightRadar24 data, we are now back to 75% of 2019 flight volumes, surpassing for the first time since the beginning of the crisis the performance in March-20 (72%)....
Another strong end-of-quarter at Airbus to boost EBIT, FCF We forecast 78 deliveries in June at Airbus, including 15 widebodies (12 A350, 1 A380 and 2 A330neo) and 63 narrowbodies (5 A220, 1 A320ceo and 57 A320neo). This would put Q2 deliveries at 173 aircraft, at 2.3x Q2 20 and 23% below Q2 19. We are thus very comfortable with our FY delivery forecast of 626 aircraft, with only 328 aircraft to be delivered in H2 (vs. 370 in H2 20). Assumptions around fixed costs underabsorption and RandD phasing continue to drive volatility in earnings forecasts, but Q2 EBIT in Commercial should be solid, potentially reaching up to EUR1bn. This is due to 48 more aircraft being delivered q-o-q, and a good mix in narrowbodies (49% A321, including 37% A321 ACF). FCF could also be a positive surprise once again, with an expected 25 less aircraft on the balance sheet vs. end Q1. This finished aircraft inventory unwinding should offset the required increase in parts inventories ahead of the A320 production rate increase to 43/mo (vs. 40) in Q3 along with some drop in pre-delivery payments inflows. Delivery mix starting to normalize at Boeing For Boeing, we expect 82 deliveries in Q2, including 52 MAX and 12 787. We note that deliveries have started to shift away from the US (35% of deliveries in Q2 vs. 71% in Q1), owing to a greater share of deliveries to Europe (c. 30% in Q2 vs. 17% in Q1), as airlines such as Ryanair and Icelandair are now taking deliveries of the MAX, as well as higher deliveries to Asia (c. 15% vs 1%). Airbus deliveries have remained relatively balanced across all regions, although deliveries to India have remained subdued in Q2, at 5% vs. the typical c. 10% level. Good OE recovery ahead at Safran, Rolls-Royce surprisingly resilient on solid A350 YTD, the LEAP is seeing a huge jump in deliveries, owing to the MAX return to service and as market shares on the A320neo have reached c.60%. This is slightly above targeted 55% for the year under...
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A good month for deliveries at Airbus, Boeing remains penalized by 787 audit We forecast 53 deliveries in May at Airbus, showing some progression vs. April but not yet returning to the very strong March levels. This includes 47 narrowbodies (3 A220, 3 ceo, 41 neo) and 6 widebodies (1 A330, 4 A350 and 1 A380). Deliveries remained largely driven by Asia, although unsurprisingly in May India dropped well below its typical 10% weight in deliveries with an estimated 2 aircraft. For Boeing, the picture remains weaker, with an expected 21 deliveries, driven by 14 737 MAX, but with only one 787 as deliveries are once again halted by an FAA audit. Fleets return to service - with a clear preference for the younger types Up until February, the number of Airbus and Boeing aircraft in service had been stable vs. Oct-20 levels. By April, this had improved by 5% above, but May saw a bit of uptick with in-service fleets now 10% above Oct-20 levels. We assume this is in preparation of the summer season, with marked differences across fleets, with A320neo and 737 MAX key drivers, along with A350, A330neo and 787 for widebodies, but 737 NG and older, 777, 747 and A340 being key laggards. Traffic recovery appears to continue but on stable flight volumes Domestic traffic remains strong, with China having already recovered to c. 12% above 2019 levels in April, while US passenger volumes (including international) have continued to recover and reached c. 70-75% of 2019 levels by end May. However, commercial flight volumes have hit a plateau, which seems to indicate some improvement in load factor, in particular for domestic flights. 737 MAX production starts to accelerate - European deliveries set to boom in June Production for the MAX seems to be accelerating, with 8 performing their first flight in May vs. an average of 5/mo since the beginning of the year. While still far from the 31/mo target in early 2022, this is a positive for the supply chain, which...
We recently attended a couple of conferences dedicated to civil aircraft engine leasing and support. These are usually good sources of information on the trading environment of engine makers in their aftermarket. The sentiment was mixed this year, as the environment remains highly uncertain. This is supportive for our cautious stance on engine makers compared to civil OE given the lack of predictability on volumes over 2022-23. Overall, industry leaders report that airlines retain ample flexibility to deal with remaining maintenance requirements, with some margin for manoeuvre baked into their fleet. Green-time engine leasing has not been extensively used yet and remains a flexibility solution. The number of shop visits has dropped, and workscope is said to be under material pressure, with mostly hospitals visits and modular repairs being conducted, and no full overhauls. A large number of used parts are expected to become available over time from future aircraft retirements, especially on the V2500, but in uncertain conditions. Recovery in the workscope at shop visits (SV) is today expected for 2023-24 when full overhauls resume. But there is no certainty as to how much of that demand will be absorbed by used parts.
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April pauses after a strong March Airbus deliveries slowed down in April after a very strong March. This is no surprise given company comments during the Q1 earnings call, but with 47 expected, deliveries were still solid and close to production levels (c. 50/month) albeit well below the tally of 72 in March. In detail, we expect Airbus to have delivered 3 A220, 3 A320ceo, 34 A320neo, 1 A330neo and 6 A350. Boeing is not spared either, owing to another pause in 737 MAX deliveries. In total we expect Boeing to have delivered 17 aircraft in April, driven by 8 787, 4 MAX delivered before the electrical issue was identified, 3 777 and 2 767. In both cases, April expected deliveries are multiple times above last year''s levels, which bore the brunt of the COVID-19 crisis. Boeing still largely reliant on US deliveries; watch out for slowdown in India at Airbus The US represents the main destination country for deliveries YTD for both Airbus (22% of deliveries) and Boeing (65%), the sole similarity on delivery mix. Indeed, Airbus'' main region of deliveries is Asia, driven by China (21% of deliveries) and India (10%), followed by Europe (21% of deliveries), while Boeing has few deliveries to Asia due to the ongoing MAX grounding. Our key takeaway from this analysis is that Airbus may face some slowdown in India deliveries, but the recent surge in traffic in China may help offset this, while Boeing needs an acceleration of traffic in either Latin America or Europe to sustain MAX deliveries as US demand may be saturated. LEAP dominant in A320neo production, 787 stockpiling ends, MAX pauses Since the start of the year, LEAP engines have been particularly dominant within the A320neo mix, representing 65% of deliveries and 67% of first flights. While the delivery mix expected for this year should be tilted in favour of the LEAP, it is expected to be closer to 55%; we will monitor for a normalisation of first flights in this direction. With regards to the...
Airbus and Boeing March deliveries are solid, as traffic recovery is highly geared to the US Commercial flights volumes stood at 68% of 2019 levels, the highest since March 2020, and an encouraging sign after the pullback seen in January and February. Trends vary greatly across geographies, however, with China facing further deterioration of air traffic to 45% of 2019 level in March (vs. full recovery in Sept) while the US recovery continues (March at 52% of 2019 levels vs. 40% over January-February). Europe should remain extremely soft in March, due to renewed restrictions. In this context, we estimate Airbus delivered 61 aircraft in March, with 54 narrowbodies (4 A220, 3 ceo and 47 neo) and 7 widebodies (2 A330neo and 5 A350). The mix is now quite balanced with Europe, North American and Asia making up the vast majority of deliveries. For Boeing, we estimate 31 deliveries, including 21 MAX and 3 787, largely to US customers. Inventories remain high but production rate concerns are largely limited to the 787 Inventories at Airbus remain high, with c. 95 by end Q1, broadly stable vs. end 2020. Within this, narrowbodies stand just above one month of production, the A350 at 4 months and the A330 at 6.5. At Boeing, MAX inventories have started to fall as delivery resumes but production is still stagnating at around 5/month. Stored fleets in the US are reducing rapidly, a potential indication that passenger avoidance is not significant. 787 inventories are, however, a concern, at c. 80 aircraft, well above the 2020 delivery performance (53); no slowdown of production is noticeable at this stage but unless deliveries are solid in Q2-Q3, we see risks of further production rate cuts. Airbus Q1 set to be broadly stable yoy as FX helps offset lowered production impact For Airbus, we expect deliveries to be down 7% in Q1, largely driven by fewer A350. Commercial EBIT should thus be broadly similar to Q1-20, with some headwinds from lower production -...
2020 results provided more visibility on the medium-term cash recovery Rolls-Royce''s FY20 results led to no change in the 2021 FCF outlook at GBP(2)bn. While in itself this may be somewhat reassuring, we could see a c. GBP300m headwind to this outlook materialise if flight hours were to stagnate yoy, a scenario which has grown in probability over the past month. The key news from the release was the clarification that the GBP750m+ FCF target as early as 2022 was conditional on a return to 80% of 2019 EFH, vs. 90% initially. While timing of cost savings seems to be a key offset for lower flight hour assumptions, the announcement still allayed some of the concerns about short-term headwinds. We also welcomed the disclosure on FCF evolution, which help understand how the group could move to solid cash generation beyond 2022, and possibly reach above GBP1.5bn. Is another rights issue needed? Possibly not, but short-term outlook still risky During the conference, management displayed confidence in their current liquidity level (GBP9bn excluding a further GBP1bn extension of the UKEF part-backed loan), which should be more than enough to weather even the group''s downside scenario. We also wonder how firm the company''s target of returning to investment grade rating around 2023 is. Should the group give itself more time, the risk of another rights issue would be greatly reduced, we think. Still, some risks remain over the short-term of moving towards the group''s downside scenario or failure to deliver on the ITP disposal, thus forcing Rolls-Royce to seek more equity. Neutral reiterated as we wait for more visibility on the traffic uptick We have updated our estimates to reflect a slower return to shop visit volumes in Civil, impacting mainly 2022 EPS, offset by a slightly stronger performance in Power Systems, thanks to margin expansion beyond the 10% level previously expected and, from 2023 a stronger recovery in IAE royalties. We slightly tweak...
Rolls-Royce beats estimates on revenue, but profitability missed expectations. In terms of guidance, the prospects are a tad gloomier than previously thought, resulting in a lower FCF expectation against the consensus for 2021. However, cash generation should improve materially by 2022 as the recovery along with restructuring actions pay off.
Airbus deliveries expected down 31% yoy to 38 aircraft February is the last month facing a pre-crisis comparison base and as such, the 38 deliveries we expect for the month represent a 31% yoy decline, driven by widebodies, expected down 80% to only 2 A350. The rest of deliveries consist of 1 A220, 2 A320ceo and 33 A320neo. Asia remains the largest destination, representing about half of total deliveries for the month, half of which are to China. February should also see the cancellation of the last 88 A320neo on order for Norwegian. Boeing momentum easing due to a very gradual return to service for MAX We estimate that Boeing delivered 24 aircraft in February (two 737 NG, 19 MAX, two 767, one 777), as the MAX momentum seems to ease. While production has stepped up, now at c. 5/month, the return to service remains very gradual, with 93 aircraft now in service, of which 53 in the US. 787 deliveries remained paused due to inspections, and March may see a resumption. Aircraft inventories remain quite high vs. production rates, especially on 787s For Airbus, we estimate that about 85 finished aircraft are in the inventory at end February. Note these figures can differ from Airbus'' tally (i.e. just below 100 aircraft at end 2020) as we look at first flights to track finished aircraft. Still, this represents over c. 2 months of production, still quite an inflated level as the typical level for Airbus is c.1 month. Boeing inventories are inflated by the MAX crisis, but 787 levels are also worrying, representing over a year''s worth of deliveries, at c. 75. Weak 2021 start led to weak guidance, some may yet see further downside risk 2021 started weaker than expected in terms of traffic, notably with a marked pullback in domestic China traffic, which dipped in January below June-20 levels, and global daily flight volumes down sequentially in February. Despite a slight recovery in late February as per FlightRadar24 data, our fear of a weak winter...
22 deliveries expected at Airbus We expect a decent month for deliveries at Airbus in January, taking into account the strong performance in December. With 22 deliveries, this would still be down c. 30% yoy, for one of the last months with a pre-crisis comparison base for Airbus. We expect narrowbodies to account for almost all deliveries this month with 1 A220, and 20 A320 (incl. 16 neo), and only one A350 delivered. There were no orders in January, nor any cancellations. Boeing recovering as 737 MAX returns to service At Boeing, we expect 29 deliveries, including 23 737 MAX, with Boeing apparently experiencing no bottlenecks in delivering MAX from its inventory. Note that three first flights took place in January, which could mark a step-up in production rates at Boeing. While a first positive sign for suppliers (Safran, Meggitt, LISI), significant increases are still needed to reach the targeted rate 31/month by early 2022. At this stage, only five airlines have returned a total of 41 MAX to service, an increase from the 20 aircraft in service as of end 2020, and the recent lifting of the grounding in Europe and the UK should help accelerate this trend. Other deliveries at Boeing include five widebodies and 1 737 NG. Boeing also recorded orders for 27 Military 767 and four 777 freighters. Flight volumes have softened in January While the delivery momentum appears relatively solid given the situation, air traffic was once again under pressure, as more lockdowns and travel restrictions were being rolled out in Europe. For the first time since March-20, the number of commercial flights in January vs. the 2019 base has dropped, to 62% (vs. 64% in December). While now well-known and reflected in the sector''s outlook - including Airbus'' production plan - this softness could still trigger some pressure on consensus estimates ahead of the Q4 results season.
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Stronger finish than expected at Airbus helps clear inventories 2020 brought a challenge in assessing December deliveries as airlines may well not have rushed to accept them. Still, taking a more cautious approach than usual to assess which aircraft have been contractually delivered, we estimate Airbus delivered 562 in 2020 (December: 85 including 66 A320, 6 A220, 9 A350 and a solid 3 A380), in line with recent press comments pointing at c. 560 aircraft. This would be well above consensus''s 528, an upward risk we flagged following the strong November deliveries. Inventories thus fell to c. 65-70 aircraft at year-end (135 at end Q3). 737 MAX deliveries finally resume - at a good pace Boeing also saw a good level of deliveries on the 737 MAX with 24 delivered since 8 Dec, of which only three were built in 2020. While it is unclear if this pace of delivery from Boeing''s now c. 430 of inventory can be sustained, it is a solid performance in less than a month. Production remained slow with seemingly no first flights in the month. Q4 impacts: strong EBIT, FCF may be curbed by other WC effects at Airbus At Airbus, the higher deliveries, and good mix skewed towards A321neos, would suggest EUR0.3-0.5bn upside on consensus Commercial EBIT. At FCF level, higher deliveries should generate c. EUR1.1-1.4bn upside to consensus; however, Airbus may see some offsets such as more lenience in payment terms from customers, to avoid cannibalizing 2021 FCF. For engine OEMs, especially on narrowbodies, this may lead to a slight cash headwind, as concessions payments are collected by airlines on delivery. Dassault Aviation also enjoyed a solid year-end, with an expected 35 deliveries, 5 more than guided, though orders may prove a better indication of direction of travel. Europe once again facing increased restrictions while operational data hold up December saw the roll-out of vaccination campaigns, at the same time as a further tightening of restrictions in...
Rolls-Royce issued a trading update as of November. The Defence business remained resilient while the situation in civil commercial aerospace was more contrasting. The recovery is still fluid, with a few uncertainties still to overcome in 2021 but visibility in 2022 should be better. Still, we see the cash generation capability of the company will remain under pressure.
Uncertainty remains in large civil aero Large civil aero engine flying hours are set to exit 2020 at a lower level than expected, currently trending at 42% of the 2019 level, below the FY20 base case of 45%. Flying hours to recover more slowly in the first half of 2021. A stronger recovery in H2'21 is still anticipated, aided by the vaccine rollout. There is a large degree of uncertainty around FY21 free cash flow (INVe: £850m outflow, Rolls-defined), both in terms of an underlying widebody market recovery and cash generation potential. Some airlines are coming forward as unable to meet their contractual minimum engine flying hour terms, so there will be an increased debtor balance in the FY results against these customers' amounts due. The prevalence of customer credit notes is also increasing (e.g. for Trent 1000 in-service issues, credit notes were issued rather than cash remediation; these are now being 'cashed in'). We therefore see a risk that there will be a disconnect for Rolls between a widebody market recovery and corresponding cash receipts. Also highlighted on the call was the phrasing of management’s target of "at least £750m of FCF as early as 2022", i.e. it could be later. In-service issues In-service issues found on 20% of high-cycle Trent XWB engines, unchanged from the August update. Target achieved of zero aircraft-on-ground due to Trent 1000 in-service issues (ability to do maintenance work aided by lower activity due to COVID); development work on the final Trent 1000 technical fix (HPT blade) is on track for FY21 deployment. CFO search The CFO search is still ongoing. The CEO hopes to have an update on this around the time of the FY results in Q1 2021. FY results will be published on 11 March 2021
Slightly more subdued deliveries in November at Airbus We forecast 52 deliveries at Airbus in November, a step down from the 70 delivered in October. Being in line with production, this implies no reduction in finished aircraft inventories this month, estimated at c.120 aircraft. In detail, we expect deliveries of one A220, 46 A320 (1 ceo), and five A350 with no orders nor cancellations this month. Into the year-end, airlines'' acceptance of deliveries is likely to be under much scrutiny, as the typical rush to deliver on targets may be replaced by a much quieter December. Still, Airbus has been adamant that there are levers - other than delivery volumes, which remain uncertain - that could be pulled to reach its FCF target. 737 MAX getting ready for delivery resumption Meanwhile, the 737 MAX has now been re-certified by the US FAA, and the first airworthiness certificate has been issued since the grounding. This means US-domestic deliveries could resume in December, but elsewhere some hurdles still need to be cleared, notably in Europe (consultation until year-end), Canada and China (likely to lag). Production remains extremely low, with only one new aircraft coming off the line each month, as Boeing evidently prioritises clearing its existing inventory vs. optimizing production in the current environment. Deliveries in November should thus remain low, at an estimated 10 (one 737 NG, one 747, two 767, three 777 and three 787). Commercial air traffic recovery has stalled but shows no seasonal downturn Commercial flight volumes have been broadly steady since mid-August, but against typical seasonality this means flights are now at 60% of 2019 levels in November (vs. 58% in October). Non-commercial flights (i.e. mainly biz jets) were up 7% yoy in November, confirming full recovery. Business jets performing in line with targets Business jet deliveries seem to be trending in line with their targets, with perhaps the potential to be slightly...
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We reinstate coverage at Neutral - short-term uncertainty outweighs mid-term opportunities The group''s refinancing (GBP2bn rights issue, GBP2bn bond issue) has allayed immediate cash concerns, driving a rebound in the share price. At 9x 2023e EV/EBIT, Rolls-Royce trades at a c. 30% discount to most of its engine peers, but this appears justified given the group''s weaker balance sheet and risks that delays to the air traffic recovery may revive liquidity concerns. That said, the successful entry into service of the Trent XWB, despite one minor blade durability issue, should provide strong support for margin recovery in Civil over the next 3-5 years, and a return to an investment-grade rating should eventually support a further re-rating. Completion of rights issue and vaccine hopes triggered a re-rating The group''s successful refinancing, including over-subscription of its new bond, and its GBP2bn rights issue triggered some share price relief. This was coupled with positive vaccine newsflow, which sent the shares up 34% over the last week. We believe the group''s cash needs are now sufficiently covered, if it delivers on its targeted disposals. Investors are also starting to look through short-term risks to air traffic given signs of pent-up demand when markets reopen. Still some liquidity concerns likely to remain given uncertain air traffic recovery timing Some concerns may arise if air traffic remains sluggish in 2021 or if divestments fail to materialise. Indeed, we detail in this note how returning to an investment-grade worthy balance sheet of 2x net debt/EBITDA would require up to GBP3bn fresh cash under the group''s ''bear-case'' scenario and absent any disposals. Lack of clear short-term catalysts and limited upside to our new GBp100 TP Following enthusiasm about vaccine news, but with still no signs of international air travel recovery, and an ITP disposal unlikely in the short term, we do not see clear catalysts in the near term....
Rolls-Royce has announced a recapitalisation package, totalling £5bn, to increase resilience and strengthen the balance sheet. £2bn rights issue Rolls has announced its intention to raise gross proceeds of c.£2bn by way of a fully underwritten 10 for 3 Rights Issue, at 32p / share, i.e. 41% discount to the TERP price and 75% discount to the closing price on 30 September. The Rights Issue is subject to shareholder approval at a General Meeting expected to be held on 27 October 2020. Our rights issue model suggests an FY22E TERP P/E of c.11x. £3bn of other balance sheet actions Also announced is the intention to commence a Bond Offering to raise gross proceeds of at least £1bn; agreed commitments for a new two-year loan facility of £1bn, conditional upon completion of the Rights Issue; and successful negotiation with UK Export Finance to support, in principle, an extension of its 80% guarantee of the existing £2bn five-year term loan to support a loan amount increase of up to £1bn. Trading update There has been no material change in the Group’s outlook since the 2020 Half Year results in August. As expected, revenue and profit for the first eight months were materially below the prior year. Consistent with the first half, Civil Aero and ITP businesses continued to see the largest impact from COVID-19 while Defence remained resilient and Power Systems saw disruption in some end markets. The Group continued to experience free cash outflows in July and August, albeit at a reduced level compared to the first half and modestly better than expectations – reflecting ongoing cost actions, large engine flying hours slightly ahead of the Group’s “Base Case” forecasts as well as some cash flow timing benefits. Full year expectations for c.£4bn free cash outflow is unchanged.
Airbus deliveries slow to 35 after a solid July; down 17% yoy This was expected, as Airbus CEO had announced the sequential recovery in deliveries would pause in August. We thus forecast 35 deliveries, comprising two A320ceo, 30 A320neo, one A330, and two A350, vs. the 49 recorded in July. However, given the typical seasonality at Airbus, August is not that weak, down a limited 17% yoy. As the group intends to cut back on inventories in Q3, September deliveries should post a solid return to growth, well exceeding July''s delivery levels. In any case, Q3 deliveries, at an estimated 84, already stand above the 74 recorded in Q2. At Boeing, we expect 10 deliveries, higher than the 4 seen in July. Capacity growth has slowed, load factors remain critical for passenger traffic improvement Capacity continued to expand in August, although the pace of growth has clearly slowed. August average daily flights thus stood 10% above that of July. If load factors do not improve this could lead to a pause in the traffic recovery. The US''s TSA data, based on passengers screened, could give some hope on this front, growing 5% vs. July, which is traditionally the busiest month in the US: August thus stood at 29% of 2019 levels (vs. 26% in July). IATA just released July passenger traffic data, down 80% yoy, with load factors still weak, just below 58% (stable month on month), although we note a somewhat steep acceleration in capacities: from 20% of 2019 levels in June to 30% in July. The key test going forward will be that of September volumes, and whether the ongoing recovery will be enough to offset the seasonal pullback. Inventories remain at a high point but growth has been curbed at Airbus So far in Q3, we estimate that a total of 110 Airbus aircraft made their first flight (our proxy for production), implying somewhat limited inventory growth of c. 20 aircraft. Airbus management has announced it aims to reduce the end Q2 inventory in Q3, of which 145...
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In this edition of the PFC, we combine the key elements of our Coronavirus Vitals, which tracks air traffic trends during the recovery from the ongoing pandemic. Quite a strong performance in July with 50 deliveries at Airbus... As disclosed by Airbus''s CEO in the Q2 results call, deliveries continued their sequential recovery, with July closing strongly. We estimate the group delivered a total of 50 aircraft in July, comprising 44 A320neo, three A220, two A350 and one A330neo. It has already been flagged that August is unlikely to see a continued sequential improvement in deliveries, but last month''s performance bodes well for the potential for Airbus to reverse some of its H1 inventory build-up as soon as Q3. We note a fairly normal regional spread in deliveries, despite key end-markets being at different stages of the pandemic (India and China account for a similar volume of deliveries for instance). ...but traffic recovery appears to be hitting a plateau, illustrating the fragility of the recovery The steep recovery in daily volume of global commercial flights, and of passengers screened at US airports, seen throughout June and early July started plateauing in mid-July. Since then, commercial flight volumes have remained at c. 50-51% of 2019 levels (June: 38%). TSA data shows a similar trend with July passengers at 26% of 2019 levels (June: 19%). On top of this, June global traffic proved to be disappointing, still down 87% yoy despite the recovery in flight volumes. IATA consequently downgraded its traffic outlook again, now expecting a 63% drop in RPK in 2020. It sees 2021 still 36% below 2019 levels, which are not expected to be reached before 2024. Production vs. deliveries: still room for improvement Despite the improvement seen in delivery rates, production - based on the number of aircraft performing a first flight in the month - still appears to be running ahead of deliveries. This is true at Boeing due to the resumption of 737...
FCF performance in 2020 and recovery path weaker than anticipated We hoped H2 20 FCF would reach break-even and the H1 GBP3bn outflow would be largely driven by inventories. However, the group now guides for c.GBP1bn of H2 outflow with H1 outflows more driven by discontinuation of factoring, leading to lower 2021-22 recovery potential. We welcome the 2022 FCF guidance of at least GBP750m, incl. GBP300m of FX hedge book unwind, but questions remain on WC and LTSA creditor growth in this mix, making profits hard to estimate. Our 21-22 EPS forecasts are cut by 9/11% on higher interest charge and slower Civil margin recovery. Flight hour volumes slightly better than feared, Q3 trends to be key Widebody engine flight hours, now guided 55% down yoy in 2020 are performing better than expected, and the slight recovery from the April trough (-80%) is encouraging. Another key step will be to see how the summer season develops, notably as international capacities timidly ramp up despite concerns on accelerating cases in the US. This would help build confidence in the H2 recovery, especially if the inferred 60% decline in flight hours over the period is surpassed. Liquidity levels remain healthy, offering breathing space to limit share dilution Rolls-Royce now enjoys GBP8bn in available liquidity, including a new 5-year GBP2bn undrawn credit line. This reinforces our confidence that Rolls-Royce will not launch a rights issue this year but wait to find buyers for its potential disposals and until it can report some earnings and FCF recovery, to limit any potential share dilution. We retain our GBP1bn rights issue estimate for 2021. FCF outlook paves way for valuation of 400p and above - short term to remain volatile Applying a relatively demanding 8% FCF yield on 2022 FCF (the AandD sector is closer to 6% on that horizon) would point to a 400p fair value (485p with no dilution). Further cash recovery potential beyond 2022 (full restructuring benefit,...
H1 trading Widebody engine flying hours were 50% lower in H1 (Q1 -25%, Q2 -75%, April -80%). MRO activity was broadly stable YoY, with the Trent 1000 backlog addressed and Aircraft on Ground in single digits. Defence activity has remained unaffected, as per expectations. Liquidity and financial position Free cash outflow of c.£3bn, with an H2 improvement expected resulting in FY cash outflow of c.£4bn. Cost mitigation actions for 2020 of £1bn are on track, with c.£300m achieved in H1. Liquidity has increased to £8.1bn, including a new undrawn £2bn 5-year term-loan facility. Making progress As a reminder, Rolls announced in May a c.17% reduction in global headcount, incurring c.£800m of cash costs across 2020-22, with total expected annualised savings from all actions of more than £1.3bn (headcount reduction contributing c.£700m). FCF target reinstated A 2022 FCF target of £750m has been introduced – we think this compares favourably with expectations despite the cash headwind from the hedge book reduction. Flying hours achieving 70% of 2019 levels by next year appear achievable on current recovering trends. Our view While management continue to review options to strengthen the balance sheet and position the business for recovery, actions to conserve cash have been decisive and it appears the storm is being navigated – today’s statement should be taken well.
The risk of a rights issue continues to weigh on the shares Rolls-Royce confirmed on Friday it is reviewing options to strengthen its balance sheet, stating no decisions have been made regarding potential disposals, which could include ITP, or a rights issue, which the press said were being considered to raise GBP1.5bn-2bn of fresh cash. We provide an analysis of the group''s indebtedness and conclude that given the potential to return to levels compatible with an investment grade rating by 2022, availability of liquidity and disposal options, launching a rights issue with the H1 trading update on 9 July may be premature. Indicative flight hours and cash flow trends from H2 should be a key focus of the update, in this context. H1 set to be poor operationally and due to one-off items We expect RR to post GBP(771)m in operating loss in H1, with a FCF at GBP(2.9)bn. This performance would be largely driven by Civil, where we factor in a GBP500m non-cash retrospective adjustment and see flight hours cash inflows dropping 65%. Other key items which could put some pressure on RR''s performance would include potential cash losses on over-hedging for 2020, along with some intangibles and tax asset write-downs. We are less concerned by the last two, being non-cash and reflecting the well-known depreciated weakened outlook. EPS cut as we reflect a steeper downturn, factor in GBP1bn of equity raise We adjust our estimates to reflect weaker air flight hours developments in 2020 (-65% yoy vs. 55% previously) and higher working capital cash burn in 2020, recovered in subsequent years. We also include a GBP1bn rights issue, which we feel would be enough, along with some facilities disposals and earnings and FCF recovery, to return to investment grade rating by end 2021. All in all we cut our EPS by 30% in 2021 and 18% in 2022. Valuation remains appealing although balance sheet concerns drive volatility On a medium-term view, thanks to the restructuring...
Airbus deliveries trend higher month on month We estimate that Airbus delivered a total of 32 aircraft in June, bringing the total to 70 for Q2. However, we highlight that the margin for error is higher than usual, and skewed to the upside this month, given a large number of aircraft which have performed customer acceptance flights but have not yet been physically delivered. Within this forecast of 32 aircraft delivered in June, widebodies remained soft (three A350, one A330), while A320neo deliveries accelerated to 28. June deliveries are down 58% yoy but have shown continuous improvement since the April trough. Q2 to be a trough quarter for Airbus with strong volume drop, inventory build-up Q2, typically a strong quarter for deliveries at Airbus, is likely to be the worst quarter of this year, with 70 aircraft representing only 31% of last year''s performance. EBIT should therefore be heavily impacted although the extent of the headwind is challenging to quantify, and compounded by the uncertainty around FX impacts due to hedging roll-forward. We note, however, that production remained well above deliveries, with an estimated c. 90 finished aircraft added to inventories in the quarter, mitigating somewhat the issue of fixed cost under-absorption. 737 MAX production resumed, more cancellations expected Production of the 737 MAX has now resumed with three aircraft performing their first flight in June. It remains unclear, however, how Boeing intends to ramp-up production going forward as the return to service is expected no sooner than late Q3/early Q4 and further fixes will have to be implemented at a later stage. June should bring new cancellations, as announced by BOC and Norwegian, with now around 10% of the end-2019 backlog cancelled YTD. Business jets prove more resilient so far in the crisis Business jet deliveries YTD across the top five manufacturers are down 29% vs. 2019, representing a much better performance than for...
17% global headcount reduction The £1bn of cash savings announced previously preserve liquidity in 2020, but given the unprecedented nature of the crisis now facing the aviation industry, Rolls is conducting a structural reduction in its cost base to adapt to the lower level of expected demand in Civil Aerospace over the medium term. The restructuring programme announced in 2018 was progressing well but a step change is now required – the minority of the headcount reductions and cost savings still outstanding on that plan will be rolled into the new reorganisation: Headcount reduction will be at least 9,000 from the global workforce of 52,000. Expenditure will be cut across plant and property, capital and other indirect cost areas. These actions are expected to generate annualised savings of more than £1.3bn (headcount reduction contributing c.£700m). Cash restructuring costs are expected to be c.£800m, spread across 2020-22. Power Systems and ITP Aero are also developing extensive measures to deal with the current situation. The Defence business has remained robust through the crisis. Our view The scale of the restructuring announced today highlights how COVID-19 is affecting the commercial aviation industry. Some industry participants do not see a return to 2019 levels of air travel until late 2023, or early 2024 for international travel. However, today’s statement may help to reassure that Rolls is taking the actions necessary to see it through this crisis. Forecasts Under Review
Market conditions and mitigating actions COVID-19 is causing significant disruption to the global aerospace industry, with an unprecedented reduction in air traffic: Widebody engine flying hours were 40% lower than Group expectations in the first four months. This reflected a fall of 90% in April. Current Board expectations are for c.250 widebody engine deliveries in 2020, vs last guidance of 450 (INVe: c.300). Power Systems has also experienced weaker trading since Q1 due to extended shutdowns in local markets and ongoing travel bans; performance in 2020 is likely to show a material deterioration compared to the prior year. A number of immediate actions to adapt to current conditions: direct procurement has been reduced, and over 4,000 UK employees are on furlough. The cash flow benefit of the Group’s actions is now expected to be up to £1bn this year, from £750m at 6 April. The cancellation of the final 2019 shareholder payment has also conserved an incremental £137 million of cash flow. An additional revolving credit facility of £1.5 billion was secured to bolster the Group's liquidity position and a successful syndication process with a larger group of banks has increased this to £1.9 billion. Looking ahead, Rolls are pursuing changes to align the business – particularly Civil Aerospace – to expected demand. FY guidance remains withdrawn. Our view Factors outside management control are clearly causing significant disruption,n but we see it as positive that further cash savings have been found, and that the Group’s banks continue to be supportive. We place forecasts, target price and recommendation Under Review.
Liquidity & Financial Position Rolls drew down the full £2.5bn RCF in March. This has been placed on short-term deposit. Including this, current gross cash is £5.2bn – this is equivalent to c.4 months of revenue. An additional £1.5bn RCF facility has also been agreed with a consortium of banks, taking total liquidity to £6.7bn – equivalent to c.5 months of revenue. The liquidity headwind related to COVID-19 in the first quarter was approximately £300m, and largely relates to the last 6 weeks of the quarter – before the impact of any mitigating actions. The Group has one outstanding debt maturity in 2020, a $500m bond due for repayment in the second half. The statement reminds us that none of the Group’s borrowing facilities contain any financial covenants nor are they dependent on (public) credit ratings. YTD trading Primary impact has been on engine flying hours, Q1 Widebody flying hours fell by c.25% vs FY19 and c.50% in March, with further deterioration expected. Preparations are also being made for an anticipated reduction in engine delivery and MRO volumes. Power Systems delivered a relatively resilient performance in a weaker trading environment in Q1, albeit management expect the reduction in economic activity to affect FY performance, particularly in industrial markets. Defence activity remains in line with expectations, with no material operational or financial disruption in Q1. Cash preservation society The company is executing a number of specific mitigations to reduce cash expenditure which will have a cash flow benefit of at least £750m in 2020; excluding ongoing transformation plans. Previous consensus FCF (company-compiled) was £962m. Given the above, it does not seem unreasonable that the final dividend is withdrawn, along with 2020 guidance. We place our forecasts, target price and recommendation under review.
Rolls-Royce reported a better-than-expected set of FY19 results, beating expectations on the operating profit and FCF lines. The performance was largely driven by Aerospace. Management reaffirmed its £1bn FCF guidance for 2020. We were given litle detail about the 2019-nCoV outbreak, except an unquantified impact on air traffic growth in the near term. All in all, a good development in H2 19, but uncertainties remain in our view.
FY19 results: adj. EPS 15.9p vs consensus 13p albeit wide range Revenue in line with consensus and our estimate at £15,450m; organic constant currency growth + 7%. Underlying Op. Profit 13/23% ahead of INVe/cons, at £808m; underlying margin of 5.2% (INVe: 4.6%, cons. 4.3%). Adj EPS of 15.9p – c.18p pre-IFRS16 vs INVe 18.3p, cons. 13p (range 8.8p-16.5p) effective tax rate came in at 47.9%. Final dividend of 11.7p, flat on FY18. FCF £873m vs INVe £686m (cons. range £567m-£776m). Flat inventory YoY (in line our expectations) should be taken well. Net cash £1,361m vs INVe £989m. Key highlights: Signs of progress in Core businesses Civil Aerospace: Record 510 widebody engines delivered, widebody OE loss down 14% to £1.2m. 7% growth in large engine installed base flying hours. Market share on new widebody orders of 64% in the year. Defence: Strong book to bill of 1.6x, record £5.3bn order backlog. Trent 1000: Guidance unchanged from November update. Outlook: Positive, albeit excluding any impact from COVID-19. 2020 ambition remains for £1bn FCF (INVe £911m) and medium-term FCF/share >£1. Following build rate reductions, widebody engine delivery expectations for 2020 now 450, 400-500 per year medium-term. Our view Strong performance on profit and cash in the year, and unchanged guidance, should be taken well, albeit outbreak of COVID-19 represents a macro risk and is likely to have an impact on air traffic growth in the near term. We continue to have concerns around long-term value creation given widebody build rates and risks to market share. Results presentation at 0830: webcast: https://www.rolls-royce.com/investors/
Rolls-Royce Holdings (RR. LN, £15.0bn) | IMI (IMI LN, £2.9bn) | John Wood Group (WG. LN, £2.5bn) | Senior (SNR LN, £788m)
RR/ IMI WG/ SNR
H1 results summary – higher H2 cash hill to climb H1 underlying revenue +7%, Group revenue +5%. Underlying Civil Aerospace revenue up 11%, Power Systems up 6%, Defence up 2%; ITP Aero up 23% Underlying operating profit up £48m to £203m; significant improvement in Civil Aerospace to a £21m loss, large engine flying hour growth +8%, strong growth in Power Systems +20%, solid growth in Defence +2% and an 18% decline in ITP Aero. H1 core free cash outflow of £391m vs. an outflow of £72m last year, worse than we expected. This is expected to improve in H2 as inventory reduces. Trent 1000 in-service costs increased by a total of c.£100m across the next three years. This is disappointing albeit relatively minor. Related customer disruption remains. Restructuring is deemed on track with £134m run-rate cost savings and an acceleration expected in H2. FY guidance and cash targets unchanged: The statement reiterates FY guidance for Core underlying operating profit and FCF of £700m +/- £100m More importantly, at least £1bn free cash flow in FY 2020 is reaffirmed. Mid-term ambition > £1 CPS Market environment: Air traffic growth is at the long-term trend level of 4-5%. This appears at near term risk in the current macro malaise. Stable widebody airframe build-rates are expected short to medium term; widebody order backlog stands at 2,136 engines Global defence markets remain stable with a number of appealing mid-term growth opportunities FCF yield is looking more interesting: On our estimates that we do not expect to materially change at this stage, the shares trade on FY19E Adj. EV/EBITA of c.24x (FY20E: c.18x), FCF yield of c.2.4% (FY20E c.4.1%).
RR’s H1 results were mixed. The charges related to both the ongoing restructuring and Trent 1000 issues remain a drag. Although management confirmed its full year guidance in terms of core operating profit and free cash flow, we stick to our negative view. The benefits are not yet visible and this is likely to remain the case through to 2021.
Rolls Royce reported better than expected FY18 results. Civil Aerospace and Power systems have experienced solid progress. The positive news also came from strong FCF at £641m, above consensus expectations. On the other hand, RR increased its T1000 charges by £236m due to customer disruption costs. RR posted encouraging results but the 2019 outlook is not surprising. We prefer to remain cautious on the stock at this stage.
Rolls Royce reported solid FY results, coming in above expectations in terms of revenues, profit before tax and EPS. The bottom line has actually been supported by lower R&D costs while the gross margin deteriorated due to an unfavourable mix. The group has also seen its FCF strongly improving compared to last year, though remaining well below underlying profit. The outlook looks rather solid in terms of revenue growth, but still under pressure and uncertain in terms of operating margin.
Rolls Royce reported a strong set of H1 results, boosted not only by a rising gross margin level but also by foreign exchange benefits. Organic revenue growth (+6% yoy) was driven by foreign exchange benefits (+5%). Drilling down into more detail shows that revenues from services posted the strongest growth (+8%) while OE revenues grew by 5% organically. The underlying gross margin grew from 16.8% to 18.2%. Profit before financing followed the same trend, rising from €158m to €345m thanks to the Civil Aerospace, the Power Systems and to a lesser extent the Defence Aerospace divisions. On the contrary, the situation remained difficult in both the Marine and Nuclear divisions.
Rolls-Royce’s underlying performance in FY16 was ahead of both its own and market expectations. Media focus on the non-cash £4.4bn headline FX loss is missing what looks to be the basis for optimism. As the civil model starts to move from investment in engines for the A350 and A330neo into the aftermarket delivery phase over the remainder of the decade, we think cash flow is likely to improve, particularly if supported by an eventual recovery in Marine.
Rolls Royce published its FY results with reported figures very different from the underlying ones because of the non-cash impact of the £4.4bn mark-to-market revaluation of derivatives and the £0.7bn charge for financial penalties. Underlying revenues decreased by 2% excluding currency effects, mainly impacted by the Marine activity (-24% vs 2015). The operating margin has been even further impacted and in all activities apart from the nuclear activity. The declining but still positive FCF has allowed the company to distribute a final payment dividend of 7.1p/share. For 2017, RR gave quite a modest outlook, not a surprise after having suffered a lot in 2016, with revenues expected to be almost flat and a slight improvement in margins thanks to transformation savings and increased aftermarket cash revenues in civil aerospace.
In January 2017, Rolls Royce agreed to pay penalties totalling more than £671m to avoid going to a full trial over allegations of bribery and corruption following a complex investigation by the UK’s Serious Fraud Office. It will be settled by paying £497.3m to the UK authorities, $169.9m to the US Department of Justice and $25.6m to Brazil. Intermediaries acting on behalf of RR were accused of making improper payments and gifts to secure deals for engines for civil and military aircraft and for industrial energy generation equipment. Moreover, the company will have to write down (non-cash) the value of its hedge book, following the Brexit vote and the fall in sterling, from $35bn to less than $32bn. These major headwinds should, however, mark a bottom concerning earnings. Indeed, it should report tomorrow profits of about £700m (compared to £1.4bn in 2015) but these are expected to bounce back in 2017 to more than £800m with Mr East reorganising the group.
Rolls-Royce revealed during its capital market day a mixed performance and outlook in the short term, while estimating a negative FCF for FY 2016. It also gave details on the impact of the IFRS 15 new standards which set new revenue recognition rules.
The cost-cutting and strategic priorities identified by the new management do not address the fundamental weakness in its business strategy. The seeds for recent profit warnings were sown back in 2011 with the decision to exit narrow-bodies and compete with GE in large engines without any distinctive competitive advantage and a weaker balance sheet.
The cost-cutting and strategic priorities identified by the new management do not address the fundamental weakness in its business strategy. The seeds for recent profit warnings were sown back in 2011 with the decision to exit narrow-bodies and compete with GE in large engines without any distinctive competitive advantage and a weaker balance sheet. Risks of further short-term disappointment due to excess wide-body capacity. Structural shift: The gulf between RR and GE (and now Pratt & Whitney) is set to widen from 2017 as the next-generation narrow-bodies (A321neoLR, 787 MAX 8) begin to penetrate the medium haul routes and threaten the cash flows expected from RR’s growing wide-body installed base. RR may have the opportunity in the narrow-body market should Boeing decide to launch a replacement for B757, but it will need fresh equity given c£2-2.5bn needed to develop a new engine.
Rolls-Royce released what can only be considered a poor set of H1 results however this had already been flagged by management with profits expected over the course of H2. Revenues and profits were down across all divisions (revenues down 5% to £6.14bn and profits before financing and tax down 70% to £158m) with continued particular weakness in Marine (revenues down 25% and loss-making half year) and a 91% fall in Aerospace profits on only a 5% decrease in revenues due to the product mix effect. The only positive was cash consumption which was better than expected with FCF a negative €399m, suggesting an improvement in cash and working capital management. The dividend for the half year was halved to 4.60p as had been previously announced. The transformation initiatives are well under way with gross savings of £50m in 2016 and a further £150-200m targeted for 2017. Rolls-Royce also announced that the changes in IFRS 15 would have a material impact on company reporting with transitional accounting required. We expect this to very much benefit the company in the longer term as it will bring reported profits much closer to cash generation. The FY16 guidance of marginally lower revenues and an overall halving in profit before tax vs. 2015 was confirmed.
By stating that the company is well set for “solid H2” supported by “growth in engine deliveries, stronger aftermarket revenues and incremental benefits from ongoing restructuring programmes”, the management has set the stock for a huge disappointment. Airlines are struggling as traffic is slowing sharply and the risk of large-scale deferrals and cancellations of schedule flights is increasing. A mere 5% cancellation will make a mockery of the £150-200m cost savings being promised. Long-term, cost-cutting is not going to change the history of value destruction and the strategic error to exit narrow body engines in 2011. The next generation narrow-bodies such as long-range A321 will soon start to make in-roads into medium-haul routes such as transatlantic flights currently served by wide bodies. Rolls-Royce will have to spend billions re-entering the narrow body market to maintain its market share. SELL, there is nothing here to get excited about.
The shares have jumped 10% since Brexit with the company reminding investors that the weakness in sterling against the US dollar and the Euro will have helped the translation of revenues and profit before tax. However, this assumes that underlying dynamics are unchanged. If that is the case, why have airline stocks, which have been under pressure due to excess capacity and rising oil prices, been hit further since Brexit? Banks, which provide 28% of aerospace financing, have also been hit hard since Brexit (see chart below). Quite how the market expects the commercial aerospace delivery schedule to stay on course while buyers and financiers are in turmoil is not clear to us. We expect delays and cancellations, which will hit RR’s balance sheet as it ramps up production rates. We have not changed our view that the company will need equity to strengthen the balance sheet.
Rolls-Royce continues to work through its current investment phase and external economic turbulence has not further damaged the prospects. The current shortfall in cash flow performance is being addressed. We believe the strength of the core civil engine model should ultimately reassert itself, lifting equity value towards significantly higher cash valuations.
Rolls-Royce delivered a set of results which contained very few surprises given that the guidance had been seriously reviewed last November (please see our Latest of 27/11/2015). Headline figures: The order book grew by 4% in value terms, underpinning Rolls-Royce's confidence in reaching a 50% market share in the long haul engine market for Civil Aerospace. Underlying revenue was £13.4bn (FY14: £13.9bn), down 1% at constant exchange rates. Underlying profit before tax was £1,432m (FY14: £1,620m), down 12% at constant exchange rates but stood at £1,355m before one-off items, in line with the lower range of the 2015 guidance of £1,325-1,475m. Restructuring programmes started prior to November 2015 continued to make good progress and are expected to generate annualised cost savings of £145m by the end of 2017. The final dividend to shareholders has been cut by 50% to 7.1p per share (14.1p for 2014). The trading outlook for 2016 remains unchanged. Looking at the results from a divisional standpoint: In Civil aerospace (revenue: £6,933m in 2015 vs. £6,837m in 2014; underlying profit before financing: £821m in 2015 vs. £942m in 2014) Underlying revenues were up 3% as aftermarket revenues grew strongly to offset lower new engine sales. Underlying profit before financing, however, fell 14% reflecting the lower gross margins due to an adverse mix and higher R&D charges. These were partially offset by life-cycle cost improvements, retrospective long-term contract accounting benefits, a reversal of impairment of Contractual Aftermarket Rights and lower restructuring costs in 2015. The order book for the segment grew by £3.8bn with notable orders for the Trent 900 and XWB. The Trent XWB now represents close to 50% of the RR order book. From an operational standpoint, the new engines development programmes (Trent -1000 TEN, XWB-97 and 7000) are all said to be well on track for entry into service between 2017 and 2018 with the company looking to ensure that the supply chain is ready and delivers cost savings through volume increases during the ramp up in the next five years. Defence Aerospace (revenue: £2,035m in 2015 vs. £2,069m in 2014; underlying profit before financing: £393m in 2015 vs. £366m in 2014) Underlying revenues fell 5% impacted by weaker helicopter and trainer volumes but this was partially offset by higher combat OE sales. Underlying profit was, however, up 4% as a flat gross margin and reduced restructuring costs offset the higher R&D charges during the year. Rolls-Royce maintains its strong positions in transport & patrol as well as the combat aircraft markets so that the performance for 2016 is expected to be steady. Rolls-Royce continues to adjust its footprint and cost base to reflect the evolution of programmes and is set to invest $600m in Indianapolis over the next five years to improve the cost base and benefit long-term growth. Power systems (revenue: £2,385m in 2015 vs. £2,720m in 2014; underlying profit before financing: £194m in 2015 vs. £253m in 2014) Underlying revenues fell 3% as a result of weaker OE sales which were partially offset by solid growth in services. Underlying profit before financing stood 15% lower as the OE fall impacted the gross margin as well a less favourable sales mix. The outlook for 2016 remains positive with the stable order book offering some visibility. Rolls-Royce suggested that it would look to increase R&D spending in the segment to improve cost competitiveness and develop market opportunities. Marine (revenue: £1,234m in 2015 vs. £1,709m in 2014; underlying profit before financing: £15m in 2015 vs. £138m in 2014) Marine saw underlying revenues fall 16% following the collapse in the offshore markets which impacted both OE and aftermarket revenues, resulting in a fall of 94% in the underlying profit before financing as the gross margin melted to £260m from £425m. The £165m fall came as a result of lower volumes and higher restructuring costs that were not compensated by a reduction in commercial and administration costs. The outlook for 2016 remains very challenging as it seems the bottom is yet to be reached in the oil & gas market. Rolls-Royce has launched two restructuring programmes in 2015 to adjust the manufacturing footprint as well as reducing administrative positions with the benefits expected to start impacting performance from 2016 onwards Nuclear (revenue: £687m in 2015 vs. £638m in 2014; underlying profit before financing: £70m in 2015 vs. £50m in 2014) The Nuclear segment saw underlying revenues climb 9% thanks to strong service revenues, in particular from the military submarine work. The mix, however, meant that before exceptionals (£19m R&D credit) underlying profit before tax was flat. Guidance is for a flat overall performance in 2016 but the aim remains to improve operational performance as well as developing civil nuclear opportunities. Investments are required in the medium term to expand the product offering and therefore the recurring services attached.
With the company reporting its full year results on February 12th, we would expect increased speculation over the next week on dividend cuts and further profit warnings. Frankly, it is not hard to make a case for at least another profit warning given the further deterioration in commodity, credit and currency markets since November and first signs that airlines are not exactly queuing up to take delivery of wide-body aircraft. The key question is whether the management can pre-empt continued speculation regarding further profit warnings and concern over its balance sheet by taking the bold step of abandoning profit guidance and shoring up the balance sheet from future shocks. We expect financial leverage to grow to an elevated range, leaving the company with limited financial flexibility to maintain its current A investment grade rating category should there be another market shock. With GE on AA or higher, it cannot afford to let its investment grade rating slip. We propose that simultaneously suspending the dividend and raising £1bn of equity next Friday could provide a floor to the share price. This will also give the new management breathing space and time to carry out the restructuring. The alternative is to pray, like many oil companies, that oil price will recover to $60/bbl and everything will be fine.
Rolls-Royce’s new CEO, Warren East, presented the conclusions of his operational review on 24 November. The key topics included: 1. The review of the portfolio: Overall the review suggests that, based on a 2020 view, Rolls-Royce has for the most part the right portfolio, as management believes that 80% of the business is exposed to attractive markets and that over 75% of Rolls Royce business has a proven competitive advantage. Within its Land & Sea business, Rolls-Royce suggests that the future for its Nuclear business is a bright one for both Military and Civil applications. For the Marine business, the review suggests that overall the portfolio of products is the right one and that a slight increase in investments over the course of the next five years should allow the business to be even more competitive on products. The important restructuring underway is expected to continue and should enable it to become even more cost competitive. The current portfolio of Defence Aerospace products highlights that Rolls-Royce is present at both ends of the product lifecycle, with contributions from mature products coming off in the next five years, but the business is well placed to capitalise on opportunities essentially in the Defence Transport and Patrol aircrafts segment as well as the emerging Combat aircraft requirements. 2. A focus on the Civil Aerospace business: Civil Aerospace warrants a separate review given that it holds the most growth potential and value generation. Before tackling the widebody segment, which holds the core of the value. The review suggests that Rolls-Royce still holds a great position in the large business jets segment, a rapidly declining position in the regional jet business which should shrink by 2/3rds over the next five years and a residual position in the narrowbody market through its position as a supplier to Pratt & Whitney. Warren East made it clear that the narrowbody technologies would continue to be developed through an R&T and R&D spending effort but effectively Rolls-Royce would not bid to re-enter the market before Airbus and Boeing start developing replacements for the A320 and B737 in the mid 2020s with deliveries starting post the 2030s. Widebody engines have been the company’s principal focus and have concentrated the core of the group’s investment over the last decade. The commercial success is evident with Rolls-Royce expected to reach a 50%+ market share based on its current order book. The segment promises substantial returns but, as explained in the next section, the business model is a complex one. 3. A review of the cash generation and capital allocation policy: When looking at an individual widebody engine programme there are four cash generation phases: • Phase 1: R&D and capital investment phase which is a pure cash consumption phase. • Phase 2: Start of the manufacturing phase with continued cash losses on OE sales as the market share remains small. • Phase 3: When aftermarket sales start to outweigh OE losses the programme becomes cash positive (this point can sometimes be reached after production has stopped, 10/15/20 years later). • Phase 4: OE sales nearly ended with now large installed base in need of servicing (20-25 year period). !Cah_generation_1.png! Source: Rolls-Royce Overlapping the portfolio of widebody engines explains the cash flow generation situation, with old very successful engine programmes coming to an end (RB211), some more recent engines not generating the kind of returns that were expected (Trent 800, 500) mainly due to the lower volume in operation and the early retirement of part of the installed base. Other programmes will see their cash generation increase (Trent 700,900) as the installed base has grown and the programme enters the 3rd and 4th phases described above. Finally, the Trent 1000 linked to the B787 and the Trent XWB linked to the A350 XWB are currently in phases 1 and 2 and therefore are still consuming more cash. !Cash_flow_2.png! Source: Rolls-Royce The fast ramps-ups forecast for both programmes, given their commercial success and the significant increase in air traffic expected, should mean that both programmes should enter the cash generating phase 3 relatively early (within the next 3-4 years depending on the versions). The Trent 7000 engine, a derivative of the Trent 700 engine made for the A330neo, should also be bordering on a positive contribution by 2020. !Cash_flow_3.png! Source: Rolls-Royce 4. The layout of how the company would improve its communication and transparency over the course of the year to come: Rolls-Rolls will increase the level of disclosure by division that it includes in its financial releases. This should allow analysts to model the business better. The new framework will be implemented after the full-year results for 2015. A valuable addition will be a T+4 cash flow indication chart that will allow better modelling of WRC movements across the years which are currently very complex to do due to the Total Care model.
The key takeaway from the CMD for us was that while the management is confident of predicting surplus cash flows in 2020 it is unable to see two years ahead as the current management information systems are not capable of picking up short-term fluctuations. This creates uncertainty over cashflows and the balance sheet. If the company wants to maintain a £3bn cash buffer then the prudent step at this stage would be to raise around £1bn equity. Our forecasts show that that even if no dividend is paid next year, the company will end the year with just over £2.2bn of cash.
The last 18 months have proved to be particularly torrid for Rolls-Royce (RR), and it now needs to rebase and reset. New management appears keen to provide a more cohesive approach to the market, possibly with increased disclosure levels, but clearly with simpler messages and potentially more measurable milestones. The exact form of this should become more apparent at the investor day on 24 November. While the further reduction to FY16 guidance hurts sentiment, we believe the long-term cash generation of the civil model should remain the core investment factor. RR needs to build a conviction that it can convert its order backlog into real cash over time.
Trading conditions are deteriorating so fast that no one could begrudge the management another profit warning. Last week, the company informed us that Q3 IMS will be issued on 12th November but the probability of an unscheduled statement before this date is now more than 50%. It is clear from recent warnings from companies ranging from Caterpillar to Rotork that the capital investment world suffered a Lehman moment in August, and it is hard to see how things could have got better in September. The balance sheet pressures on the commodity complex combined with sharp depreciation in emerging markets currencies is bound to lead to delays, cancellations and renegotiations of contracts. Our best guess at this stage is that the EPS guidance will be moved from 55-62p to below 53p. We reduce our target price to 520p, from 600p.
Rolls-Royce saw its order book up £2.8bn to £76.5bn in H1 15. Underlying revenues were however down 3% to £6.3bn (H1 14: £6.5bn) and most significantly underlying profit before tax was down 32% to £439m (H1 14: £646m). The RoS was down 3.2 percentage points to 7.3%, largely reflecting the H1 15 revenue mix and a higher R&D charge. Continuing with its progressive dividend policy the payment to shareholders is increased to 9.27p per share, up 3%. Looking at the two major segments: In Aerospace, the Civil segment secured the largest ever order to provide Trent 900 engines and TotalCare® service support to Emirates, helping grow the Civil Aerospace order book to £66.4bn, up 5% on the 2014 year-end. Underlying revenues were up 2% to £4.3bn (H1 14: £4.2bn). Underlying profit was down 27% to £432m (H1 14: £593m) and, as announced on 6 July, the lower demand for Airbus A330ceo creates H2 15 and 2016 headwinds for the Trent 700 deliveries. In Land & Sea, Power Systems’s improved second quarter performance helped offset the weaker start to the year while the weaker Marine held back overall results. Underlying revenues fell 12% to £2.0bn (H1 14: £2.3bn) and underlying profit collapsed 56% to £48m (H1 14: £109m). The weakness in offshore markets is the obvious culprit and will continue to hold back full-year 2015 and 2016 Land & Sea performance. Finally, the 2015 group guidance is unchanged from 6 July. The net R&D spend is expected to be modestly higher than the £750m that was previously guided. Foreign exchange translation effects are estimated to be £450m on revenue and £10m on profit in 2015 so that Rolls-Royce expects revenues to be in the region of £13.4-14.4bn, profit before tax of £1,325-1,475m resulting in an EPS of 55-62p. In addition, FCF for the group should be in the region of -£150m to £150m with capex expected to be in the region of 600m and the net R&D spend roughly more than £750m.
Profit warnings from Rolls-Royce focus heavily on specifics. Yesterday, the attention was on weak A330, business and regional jet demand, combined with falling offshore demand. The next warning will probably blame A380 or issues in Power Systems. This is symptomatic of a company which relies on static planning models to provide precise but wrong guidance, but fails to address the fundamental problem, i.e., a corporate strategy that yields average post-tax ROCE below 5% on a capital base of £25bn. Logic says that returns have to improve. While the new CEO has embarked on a “thorough operational review”, the pressures on the balance sheet limit his options – £500m was wasted needlessly on buying back over-valued shares. There is no reason to own the stock at least until a thorough “kitchen sinking” is announced; we suspect in Sept/Oct with some, if not all, Land & Sea businesses earmarked for disposals. We are downgrading our numbers for the second time in two days.
Company has cut 2015 guidance and also identified a number of market developments in 2015 that are now expected to have a more significant impact in 2016. These primarily relate to Civil Aerospace markets, particularly for Trent 700 engines during their transition to the new Trent 7000, business and regional jets, and in the offshore markets for the Marine business. We reduce our Target Price to 600p (744p).
