Rolls-Royce targets vast upturn in profits

Unlock the Editor’s Digest for free

Rolls-Royce said it would quadruple its profits in the next four years and sell its electric aircraft division as chief executive Tufan Erginbilgic tries to make good on his promise to turn around the UK aerospace company.

The demanding profit target is the centrepiece of a long-awaited shake-up by Erginbilgic, a former BP executive who was parachuted into the top job in January to help Rolls-Royce recover from the damage inflicted by the pandemic and previous restructurings.

Under the plan, the FTSE 100 group is aiming for operating profit of up to £2.8bn by about 2027, four times the amount it reported last year.

The group is aiming to increase operating margins to 13 per cent to 15 per cent over the period. In its core civil aerospace business, it expects to achieve operating margins of between 15 and 17 per cent, up from 2.5 per cent in 2022, in a move that would bring it closer to rivals such as General Electric.

Erginbilgic said on Tuesday that the “new Rolls-Royce” would have the financial strength to invest in growth and grow shareholder returns.

“These targets are not destinations . . . They are milestones around 2027. This company, when we create that, it will continue to grow longer-term,” he told reporters on Tuesday.

Rolls-Royce is relying on cost cuts for some of the growth. It is seeking annual savings of up to £500mn and last month announced plans to cut up to 2,500 jobs. It is also targeting £3.1bn in free cash flow by about 2027.

Rolls-Royce builds and maintains large engines for widebody aircraft including Airbus A350 jets and Boeing’s 787, and earns most of its revenues when its engines are flying, as well as from after-market sales. The company’s defence business builds engines for submarines and fighter jets, while its power systems business makes diesel and gas engines for ships and for power generation.

Erginbilgic insisted that the company’s performance was already being driven by “our actions, not the environment”, pointing out that large engine flying hours, a key financial metric, were still only at 86 per cent of pre-Covid levels for the 10 months to the end of October.

He said Rolls-Royce had identified several “levers” to improve margins at its civil aerospace business, including extending the time its engines are flying, reducing maintenance costs and getting out of low-margin contracts.

The higher than expected profit and free cash flow targets could be taken to “imply that Rolls-Royce is willing to shed revenues in exchange for better profitability and cash flow”, noted Nick Cunningham, analyst at Agency Partners.

“If so, it is a deeper culture change from Rolls-Royce’s traditional market share optimisation approach of past decades,” he added.

The prospect that Erginbilgic will improve the group’s performance has already sent shares in Rolls-Royce up 160 per cent this year, making it the best performer on the blue-chip FTSE 100 index. The shares were up more than 6 per cent on Tuesday.

Rolls-Royce will also divest assets with the aim of raising between £1bn and £1.5bn over the next five years. The disposals will include its electrical business that develops propulsion systems for aircraft such as flying taxis. However, the company added that it remained committed to its nuclear activities in small modular reactors.

Erginbilgic said the company needed to make “choices on resource allocation”.

The company’s research and development spend, he added, would remain flat in absolute terms despite the disposals. It was just under £1.3bn in 2022.

Longer-term, Erginbilgic said the company would consider partnerships in its power generation and battery storage businesses.

In civil aerospace, the company would also consider a partnership with another manufacturer to allow it to re-enter the lucrative market for narrow-body aircraft. Rolls-Royce left the market more than a decade ago when it pulled out of a joint venture with Pratt & Whitney of the US. P&W remains the most obvious partner, according to analysts.

Erginbilgic said he expected to leverage Rolls-Royce’s new UltraFan programme of engine technologies for when the next generation of narrow-body aircraft is due to enter service around 2035.

With Airbus already working with rival CFM International, a joint venture between Safran and GE, on a hydrogen-powered demonstrator aircraft, Cunningham said the “obvious remaining opportunities” for Rolls-Royce to target would be a new narrow-body aircraft from Boeing to replace its current Max plane “and/or a longer version of Airbus’ current A220 model”.

Erginbilgic said he believed sustainable aviation fuel would be the mainstay for large jets to achieve net zero climate targets.

Read the full article here