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ROLLS ROYCE earns most of its money through servicing and maintaining aero engines as opposed to selling them. When the planes don’t fly, neither do Rolls Royce’s revenues. In 2020, the company was forced to shed more than 8,000 jobs, cancel its dividend and raise an additional £2 billion from shareholders, as it struggled to contain high fixed costs in a locked-down world. Even then it lost around £4 billion.
Investors will be hoping that performance gets reversed in fairly short order as the recovery in international travel gathers pace. Encouragingly, interim results published this morning showed operating profits rising to £307 million, compared with a loss of £1,630 million at the half-way stage in 2020. Free cash flow (-£1,174 million compared with -£2,862 million) failed to perform a similar about turn, but the company expects that to happen in the second half1.
Invoiced large engine flying hours are critical to the Rolls Royce share price and, here too, the news is encouraging. Hours rose to 43% of their 2019 levels in the first half, up from 34% in the same period last year. Chief Executive Warren East says the company has confidence in its ability to withstand uncertainties around the pace of recovery in international travel and benefit from the eventual rebound2.
Rolls Royce hasn’t been idle in making good on its plans to reduce debt. It plans to bolster its finances through disposals worth at least £2 billion and yesterday announced the sale of its Bergen Engines medium speed liquid fuel and gas engines business. This will strengthen the balance sheet to the tune of EUR110m. Talks to sell the company’s Spanish aero engine and gas turbine business – ITP Aero – have also begun. Restructuring is anticipated to generate savings of more than £1 billion in 20213.
Aside from a brief lift-off in March after the government published its spring roadmap for England, Rolls Royce shares have stayed largely grounded at around the 100p mark. With the company valued at just 0.6 times sales, investors have clearly been backing opportunities elsewhere4.
However, the worst now seems to be over and Rolls Royce shares are looking increasingly like a classic recovery play. Industry conditions are clearly getting better, as highlighted by Ryanair which said yesterday it flew more than twice as many passengers in July compared with the same month in 2020 and 75% more than in June5. As further good news like this arrives, markets are increasingly likely to acknowledge Rolls Royce’s good long term value.
Rolls requires invoiced engine hours to recover closer to pre-pandemic levels to see its shares sustainably back at high altitudes. That said there seems to have been enough in these results to start the shares moving in the right direction. It’s always worth remembering that the stock market usually discounts events months in advance of them happening. If you wait until all of the good news has flown in, you’ll miss out on the journey’s best bits.
More on Rolls Royce
1,2,3 - Rolls Royce, 04.08.21 and 05.08.21
4 - Bloomberg, 05.08.21
5 - Ryanair, 04.08.21
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