Rolls-Royce Holdings – Half Year Results

ROLLS-ROYCE HOLDINGS PLC 

2021 Half Year Results

· Good start to the year with improving cash flow and profits from continuing operations

–  Underlying operating profit £307m, up from a £(1,630)m loss in 2020 H1

–  Free cash flow £(1,174)m, significantly better than prior year (2020 H1: £(2,862)m)

–  Strong liquidity position with no maturities before 2024

· Focused on delivering to plan and driving results

–  Restructuring delivering results and expected to achieve >£1bn savings in 2021

–  Disposal programme progressing well towards targeted proceeds of at least £2bn

–  Target to turn free cash flow positive during the second half 2021

–  On track to improve FY2021 free cash flow to approximately £(2.0)bn (2020: £(4.2)bn)

· Net zero pathway launched confirming our targets and commitment to play a leading role in the transition of the markets we serve to net zero carbon emissions by 2050

Warren East, Chief Executive said: “ Our continued focus on the elements within our control, together with a good performance from Defence and order intake recovery in Power Systems have enabled us to deliver solid progress in the first half. The benefits of our fundamental restructuring programme in Civil Aerospace are evident in our reduced cash outflow and improved operational efficiency. This leaner cost base together with a strong liquidity position gives us confidence in our ability to withstand uncertainties around the pace of recovery in international travel and benefit from the eventual rebound. We are making disciplined investments in the new opportunities to drive future growth, particularly in net zero power where we are leading the way with innovation and engineering excellence. Our net zero pathway and targets, announced in June, set out our plan to enable the sectors in which we operate achieve net zero by 2050 by driving step-change improvements in engine efficiency, helping accelerate the take-up of sustainable fuels and developing new technologies. “

First half 2021 Group financial performance

For footnotes referenced in tables on pages 1-14, see page 15.

Business unit underlying performance summary

Underlying performance excludes the impact of period-end mark-to-market adjustments , the effect of acquisition accounting and business disposals, impairment of goodwill and other non-current and current assets, and exceptional items. Adjustments between the underlying income statement and the reported income statement are set out in note 2 in the condensed consolidated interim financial statements on page 28.

Group underlying revenue from continuing operations of £5.2bn, down 2%, reflected a more balanced contribution from the business units compared with the prior period. It included a positive £160m Civil Aerospace LTSA revenue catch-up compared with a £(866)m negative revenue catch-up in first half 2020.

Group underlying operating profit from continuing operations of £307m included significant cost savings from the restructuring programme, primarily in Civil Aerospace, and favourable timing and mix of activity in Defence and Power Systems. The prior period comparative underlying loss of £(1.6)bn included £(1.2)bn of one-off charges mostly related to the impact of COVID-19 on Civil Aerospace.

In Civil Aerospace, our first half operational performance saw an overall improvement with a recovery in business aviation and domestic large engine flying activity together with substantial cost benefits from our fundamental restructuring programme, which is reducing the size of our cost base by around a third. Large engine LTSA flying hours were 43% of the 2019 level, up from the 34% in H2 2020; 92 large engine major shop visits were completed and 100 large engines were delivered. We have already seen a return to 2019 levels of flying activity for our business aviation engines and for large engines operated on domestic flying routes. However, international travel is recovering more gradually, hindered by global variation in vaccination rates and ongoing travel restrictions. We are continuing to mitigate this through the actions within our control.

Our Defence business continues to perform well with resilient demand that has not been impacted by COVID-19. First half performance benefitted from improving operational performance which enabled the earlier delivery of spare engines and higher spare parts sales, which historically have been more second half weighted. This favourable timing and mix in the first half is expected to result in a stronger first half versus second half performance, hence our full year expectations for Defence are unchanged. Our strong order book in Defence gives us confidence in our outlook with £1.2bn order intake in period and more than 70% of 2022 expected revenues covered by the order book.

In Power Systems, revenues were broadly stable in the first half with an increase in services offset by a reduction in original equipment (OE) deliveries. Operating profit benefitted from a rise in higher-margin aftermarket spare parts, partly offset by low factory utilisation on OE manufacturing. Order intake was up 19% to £1.4bn (2020 H1: £1.2bn), with a 1.2x book-to-bill ratio, showing recovery in our end markets led by demand in marine, governmental and power generation markets. Interest in lower carbon solutions is growing and we are increasing our relative R&D investment in these products. The recovery in OE order intake is expected to be realised as revenue over the next 6-12 months.

Delivering on our commitments

Our ongoing focus on areas within our control – cost reduction, liquidity and operational improvement -enabled us to deliver a significant improvement in first half profit and cash flow while continuing to invest in new products, including new low carbon technology and solutions to decarbonise our end markets.

– Restructuring : We delivered further good progress on our fundamental restructuring programme with around 8,000 roles now having been removed and we expect to deliver more than £1bn of savings in FY2021 as compared with FY2019. This keeps us on track to achieve our aim of a reduction of at least 9,000 roles and run rate savings of more than £1.3bn by the end of 2022.

– Disposal Programme : Our disposal programme, which aims to achieve at least £2bn in proceeds is progressing well. The planned sale of ITP Aero is moving forwards and we continue to work closely with all key stakeholders. Although the disposal of Bergen Engines was interrupted in the first half, we remain committed to its sale and this week announced a new disposal agreement with enterprise value of €63m and €40m cash on its balance sheet will remain with the Group. We expect to complete the disposal of the Civil Nuclear Instrumentation & Control business later this year.

Strong liquidity position and improvement in free cash flow

Our liquidity position is strong with £7.5bn of liquidity including £3.0bn in cash at the end of the half year after repaying the 2021 €750m loan notes and the £300m Covid Corporate Financing Facility (CCFF) loan in the first half. Net debt (before leases) was £(3.1)bn at the period end. This week the Group signed an extension to the 2022 £1bn unused loan facility to 2024, consequently the Group has no debt maturities before 2024 (excluding ITP Aero).

Free cash outflow of £(1.2)bn represented a significant improvement on the prior year period of £(2.9)bn, which included a £(1.1)bn negative impact from the cessation of invoice factoring. The £0.6bn underlying improvement reflected good progress on cost reduction, stronger operating performance and reduced capital expenditure.

Our £2.0bn UKEF-backed 2025 loan facility, which we drew down in the first half, restricts us from declaring or making shareholder payments until 2023. In 2023, payments can resume provided certain conditions are satisfied. Therefore, no interim shareholder payment will be made for 2021.

Our priorities for capital allocation are to rebuild the balance sheet and to invest in the business to grow returns ahead of returning surplus cash to shareholders. We are focused on generating appropriate value on our disposals and improving free cash flow. This will reduce net debt and take us towards our ambition to return to an investment grade credit profile in the medium term.

Outlook and financial guidance

We continue to expect to turn free cash flow positive sometime during the second half of this year and to achieve an improvement in full year free cash outflow to around £(2.0)bn (FY2020: £(4.2)bn). This is driven by our actions to reduce costs, continued strength in Defence, growth in Power Systems and a gradual recovery in Civil Aerospace. Our guidance remains sensitive to the timing of OE concession outflows on already delivered widebody engines, as we previously highlighted in our full year results in March.

Looking further ahead, we are confident that when border restrictions are lifted the recovery of international travel will accelerate. Free cash flow of at least £750m (before disposals) is still achievable in a 12-month period when EFH exceed 80% of 2019 levels, supported by our lower cost base in Civil Aerospace which is now a third smaller. However, based on current industry forecasts for the pace of recovery in international travel, this is likely to occur beyond the initial expected timeframe of 2022. We are positive on the near-term opportunities in Defence and Power Systems and in our new business areas in electricals and small modular reactors (SMR). We will remain agile in our response to external factors , continuing to deliver on our restructuring, rebuilding our balance sheet while investing in our future.

Our net zero commitment and new low-carbon growth opportunities

In June, we announced our net zero pathway setting our short and medium-term targets and showing how we will focus our technological capabilities to play a leading role in enabling significant elements of the global economy to reach net zero carbon by 2050. To achieve this, we are developing new technologies, enabling an accelerated take-up of sustainable fuels and driving step-change improvements in fuel efficiency, within aviation, shipping and power generation. By 2030, we plan to make all our new products compatible with net zero and by 2050 all our products in operation will be compatible.

In addition to meeting the net zero challenge for our existing activities, we are also investing in new opportunities and markets, laying the foundations for future growth beyond our current portfolio.

We are at the forefront of the development of electrical aerospace propulsion systems which are opening up exciting incremental growth opportunities with significant commercial potential. Earlier this year we announced an agreement with Wideroe and Tecnam to power an electric regional aircraft by 2026. We are testing our 2.5MW power generation system for potential use in hybrid-electric aerospace propulsion. Our urban air mobility partner, Vertical Aerospace, took a step forwards in June with the announcement of its planned US listing and up to $4bn in pre-orders for up to 1,000 eVTOL aircraft. 

Rolls-Royce SMR power stations have been designed to deliver low cost, net zero carbon nuclear power and are on a pathway to be connected to the UK grid in the early 2030s with the further opportunity of substantial export potential. In addition to stable base load power, they will be able to provide energy for the net-zero manufacture of green hydrogen and synthetic fuels. We are now approaching the second phase of the programme, which will include entering the UK licensing process later this year, supported by new third party investment that unlocks multi-year UK Government matched funding of £210m.

To enable our net zero ambitions and to drive new business growth in low-carbon technologies we are increasing the proportion of gross R&D spend on lower carbon and net zero technologies to 75% by 2025.