Rolls Royce Holdings Plc (RR.) Ordinary 20p Shares

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Rolls-Royce said demand remains “strong” across business aviation and widebody markets. However, it also noted that supply chains across the industry remain “challenged”.

Over the first 10 months of the year, Large Engine Flying Hours (the key driver of revenue for the Civil Aerospace division) grew by 18%, reaching 102% of 2019 levels.

Strikes at Boeing have caused a delay in getting regulatory approval for an upgrade to one of its engines (Trent 1000) signed off. Rolls-Royce now expects approval “in the coming months”.

In the Power Systems division, strong revenue growth was driven by data centres where demand for backup systems remained high.

Full-year guidance has been reiterated, with underlying operating profit between £2.1-2.3bn and free cash flow of £2.1-2.2bn expected.

As previously announced, dividend payments are set to be reinstated at full-year results.

The shares fell 3.4% in early trading.

Our view

Rolls-Royce trading update showed it’s on the right flight path to hit full-year targets, despite ongoing supply chain challenges.

Rolls-Royce produces aeroplane engines for larger, long-haul planes. A huge amount of its revenue comes from servicing those engines, with business based on how many hours those engines spend in the air.

It was encouraging to hear that so-called engine flying hours (EFH) have now climbed to 102% of 2019 levels. That figure’s set to soar somewhere between 100-110% of 2019 levels by the end of the year as more of its engines take to the sky and demand for long-haul travel remains strong.

But bringing more revenue in the door is only one part of the puzzle. That’s why we’re impressed with the stark changes made elsewhere in the business. CEO, Tufan Erginbilgic, is a no-nonsense leader. He’s delivering on his promise to transform Rolls into a leaner, more focused company, and it’s reaping plenty of rewards.

From an operational standpoint, layoffs, contract renegotiations, process changes, and increased use of data to drive efficiencies have put Rolls on a much healthier platform. As a result, margins have moved much higher, helping to convert the increased flying hours and revenue into profits.

Despite all the positives, there have been question marks about some of its newer-generation engines, which appear to be underperforming in sandier climates. Attempted fixes are pending regulatory approval, but strike action is currently delaying sign-off. If the group can’t iron out these issues, it could eat into future profits.

With its healthy free cash flows, Rolls has made impressive headway in lowering its debt levels. That’s given management the confidence to announce the return of dividends, with the first payment due in the new year. Given the payout policy and full-year guidance, this points to around 5p per share, equivalent to a prospective dividend yield of around 1.1%. But as always, no dividends are guaranteed.

Rolls' position in the defence and aerospace industry is enviable - high barriers to entry mean there are very few smaller competitors sniffing around. And a multi-billion pound order book gives the group a good deal of visibility over future revenue.

With so much progress made in such a short period of time, the group’s 2027 mid-term targets look well within reach. We think investors should remain positive on the outlook for Rolls, but be aware that the pace of improvements is likely to slow from here. Rolls is trading well ahead of its long-term average on a forward price-to-earnings basis, increasing the chances of ups and downs.

The author holds shares in Rolls-Royce.

Environmental, social and governance (ESG) risk

The aerospace and defence sector is high-risk in terms of ESG. Product governance and business ethics are key risk drivers. Carbon emissions from products and services, data privacy and security and labour relations are also contributors to ESG risk.

According to Sustainalytics, Rolls Royce’s management of ESG risk is strong.

It has set up a safety, ethics & sustainability committee to oversee ESG issues and executive compensation is tied to performance on these issues. There is also a strong environmental policy, including a commitment to net zero and interim targets, and whistle-blower programme. However, ESG-related disclosure falls short of best practice.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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