Over the first 10 months of the year, Rolls-Royce said that demand remains strong in its Civil Aerospace business, with “significant” large engine orders. Large Engine Flying Hours (a key driver of revenue for Civil Aerospace) grew by 8%, reaching 109% of pre-pandemic levels.
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 maintained, with underlying operation profits and free cash flows expected to be between £3.1-3.2bn and £3.0-3.1bn respectively.
£0.9bn of the ongoing £1.0bn share buyback programme has been completed.
The shares were broadly flat in early trading.
Our view
Rolls-Royce continues to perform well, with third-quarter numbers showing little sign of turbulence. Strong order momentum and an upward trend in engine flying hours means that full-year guidance looks well within reach.
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.
So-called engine flying hours (EFH) are now cruising at 109% of 2019 levels. That figure’s set to soar somewhere between 110-115% 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.
We’ve also been 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, contract renegotiations, process changes, component upgrades, and increased use of data to drive efficiencies have put Rolls on a much healthier platform. As a result, margins are continuing to rise, helping to convert the increased flying hours and revenue into profits.
Rolls also has exposure to the defence sector, making up around 25% of group revenue. Given the current elevated-threat environment, defence budgets across many countries are on the rise. With positions in combat aircraft and nuclear submarines, Rolls-Royce looks well-placed to capture some of the increased spending.
Despite the positives, some of its newer engines have required much more maintenance than customers are happy with. Attempted fixes are in the pipeline, but if the group can’t iron out these issues, it could eat into future profits.
Rolls reckons it can fully offset the direct impact of tariffs on its business. But the indirect impact could see some weakness among its customers, and that’s largely outside of the group’s control.
The balance sheet looks much stronger than it has for some time. The ongoing £1bn share buyback programme is almost complete, but as always, no shareholder returns 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.
High expectations for growth have earned Rolls a premium versus its peers. The valuation isn’t as attractive as it once was, but with a growing reputation for overdelivering, we still see some upside to current guidance. However, there’s a decent amount of execution risk, and if management can’t deliver improvements on time, markets are likely to react poorly.
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.
Rolls-Royce key facts
All ratios are sourced from LSEG Datastream, based on previous day’s closing values. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn’t be looked at on their own – it’s important to understand the big picture.
