Rolls-Royce: cause for optimism in turbulent times?

Rolls-Royce reported worse than expected losses for 2020, yet investors ought to remain bullish as they look well-placed to embark on a sustainable and comprehensive recovery. The COVID-19 pandemic had a devastating effect on the civil aviation industry, for which Rolls-Royce design, manufacture and maintain engines. Whilst it is not clear that recovery from the pandemic will be smooth, investors should be encouraged by Rolls-Royce’s steps to ensure they will remain a key player in a renewed aerospace industry. There is little doubt that challenges lie ahead, however, their growth aspirations into new markets and new products should leave investors feeling optimistic.

Rolls-Royce is heavily reliant on the civil aerospace industry’s performance as a whole for its profits. Within its civil aerospace division, Rolls-Royce sign maintenance contracts for which they are paid for the flying hours that their engines accrue. As national lockdowns across the world dictated fleets were grounded, flying hours dropped significantly. E Mazareanu, writing for Statista, noted that the total global flights fell by 43.5% for the week starting January 4th, 2021 compared to the week of January 6th, 2020. Given that civil aerospace accounted for approximately half of Rolls-Royce’s total revenue in 2019 it is hardly surprising that profits fell significantly. Ultimately, however, the losses were deeper than expected. Rolls-Royce reported an underlying pre-tax loss of 4 billion GBP for the year ended December 2020, compared to a forecast of 3.1 billion GBP.

For some investors the prospect of a slow recovery from the COVID-19 pandemic is leading to a pessimistic outlook on Rolls-Royce’s performance. Forecasts for a drawn-out recovery are emerging from hurdles in the form of new variants and supply of vaccinations. Rytis Beresenevicius, writing for Aerotime Hub, identified this as a particular challenge for demand for Rolls-Royce’s engines for wide-bodied aircraft. Flying hours for these aircraft are expected to reach just 55% of pre-crisis levels in 2021; a forecast revised downwards from 70%. This is estimated to translate, according to Rolls-Royce, to a free cash outflow of 2 billion GBP for 2021.

Despite this significant free cash outflow, there is room for optimism due to Rolls-Royce’s strong liquidity position. The group raised 7.3 billion GBP in a right issue and now has access to 9 billion GBP in liquidity, having raised further credit. Even with the projected outflow of 2 billion GBP in 2021, it seems that Rolls-Royce will be able to survive in the short-to-medium term whilst demand recovers.

Moreover, the strength of other divisions, such as defence and power systems, should provide stability in the wake of pandemic-induced losses. The Chief Executive Officer of Rolls-Royce, Warren East, is seeking to reduce their dependence on civil aerospace. He credited diversification as enabling the group to navigate the pandemic thus far and expressed his desire to continue to do so. In order to achieve this, growth in African markets has been identified for its power systems division. Ben Story, Strategic Marketing Director for Rolls Royce, sees mergers and acquisition as key to the success of their development of hydrogen power and small nuclear reactors. Therefore, further acquisitions should be expected, in the style of its recent takeovers of Quinos and Kinolt, in order for it to achieve its plans.

Investors should also take confidence from Rolls-Royce’s recent attempts to become a market-leader in the shift to electrification of their aviation sector. Rolls-Royce have entered a collaboration with Vertical Aerospace to power their Urban Air Mobility aircraft (UAM). The UAM will be powered by Rolls-Royce’s electrical power system and is due to be certified as early as 2024. The UAM will reportedly reach speeds of 250-mph, with a 500-mile range, for four-to-five passengers. Additionally, in Q2 of 2021, the fastest electrical aircraft to date, the Spirit of Innovation, is due to take its maiden flight. The Spirit of Innovation is powered by a 6,000-cell battery pack designed and manufactured by Rolls-Royce. In a burgeoning market within civil aviation more broadly, these ventures show that Rolls-Royce are intent on ensuring that they are well positioned for the future of aviation. 

Whilst investors may be cautious of setbacks in the recovery of civil aviation, there is certainly scope for positivity about the prospects of Rolls-Royce. Their ambitions to enter new markets and create innovative new products should ensure success in the long term. Crucially, however, they have the liquidity to weather the short-term storm. Overall, it is becomingly evident that there is cause for hope and optimism for Rolls-Royce, despite the ongoing turbulence.

By Angus Lovatt

Sector Head: Daniel Aliwell