In October, the Rolls Royce (LON:RR) share price fell to its lowest levels since 2003, after the company announced its plans to raise extra cash to bolster its hollowed-out finances.
The launch of a £1bn bond issue as well as a £2bn 10 for 3 rights issue at a 41% discount to 130p was eventually taken up by shareholders, as the company embarked on a fight for survival after half its revenue disappeared in the wake of the almost wholesale grounding of the civil aviation industry in the wake of the coronavirus pandemic.
In 2016 Warren East, Rolls Royce CEO took what turned out to be the fateful decision to trim back underperforming areas, and focus the business into key growth areas of civil aviation and maintenance.
There were problems even before the pandemic, namely with its Trent 1000 engine which powered the Boeing (NYSE:BA) 787 Dreamliner, with cracks forming on the turbine blades, the costs of which started to spiral out of control, causing the company to post a £2.9bn loss in last year’s full year numbers. To compound this there appeared to be another issue with this power unit in reports in July that suggested a problem elsewhere, within the turbine itself.
While Rolls Royce were dealing with these problems the pandemic almost dealt the business an even more fatal blow. Maintenance is a huge revenue earner for the business as Rolls Royce derived income from the number of hours flown by its engines. The resultant shutdown in civil aviation turned off the cashflow tap almost overnight.
It will still take some time for their civil aviation income stream to return to anywhere near normal, but the hope is that in the New Year this will start to pick up again, as flight schedules start to get reinstated.
Putting these problems aside the October fundraising does appear to have bought the company much needed time to reorientate its business model so that it’s not anywhere near as reliant on civil aviation. Rolls has also sold its stake in its civil nuclear instrumentation and control business to France’s Framatome, and still expects to sell its Spanish ITP Aero business sometime next year.
That doesn’t mean that we won’t see another quarter of cash burn and today’s numbers highlight that quite starkly, but the outlook does look much brighter than it did a few weeks ago, as the vaccine program starts to get rolled out, and air travel starts to pick up again in 2021. This has been reflected in a recent Rolls Royce share price rebound to levels above 120p in recent weeks.
Today’s trading update shows that large engine hours flown were at 42% of the previous year, however this disguises the fact that in the last couple of months this was down at 33%, compared to 2019, bringing the quarterly total up to 29%, while as a result of various cost savings the business is on track to deliver £ 1bn of savings this year.
Management said they still expected to make 250 deliveries of new engines this year, and kept their full year guidance unchanged.
For 2020 the company expects to see £4.2bn of free cash outflow, while expecting to go cash flow positive at some point during the second half of 2021, with a view to generating £750m of FCF by 2022, as it looks to raise another £2bn in the form of disposals.
The defence business has remained resilient with a strong order book, with a recent order for 56 engines for the German air force.
Earlier this year the business announced the loss of 9,000 jobs, with 5,500 of these expected to have gone by the end of this year. A consultation is now taking place within its CA division to transfer the manufacture of aero engine structures into ITP Aero, before looking to sell that part of the business.
It’s also been reported that Rolls is looking at a joint venture with the Aero Corporation of China to jointly supply engines to a new wide body jet program between China and Russia.
Rolls Royce is also looking at innovation in other areas, for example, as part of the government's new energy plans the business is part of a consortium to build 16 mini nuclear plants in the UK, while it is also working on a prototype engine that uses 100% sustainable aviation fuel.
All in all this mornings numbers are symbolic of a business in recovery and that is still some way short of getting back on its feet, however things do appear to be moving in the right direction, and with at least £8.5bn of liquidity, along with a £1bn 2 year bank facility that remains undrawn, there is a cash buffer to at least see a pathway to recovery as air travel recovers in the wake of a successful vaccine rollout in 2021.
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