Rolls-Royce profits and cash flow soar above forecasts

Engine maker Rolls-Royce reported profits and cash flow well above expectations for 2017 thanks to improved revenues and a vigorous cost-saving programme, even though cash was hit by costly reliability issues in its Trent 1000 and Trent 900 models.

In-service engine issues in these two civil aerospace engine models led to total charges of £227m being taken in the year's income statement, with a £170m impact to cash flow that is expected to double to around £340m in 2018 before falling to £240m in 2019.

Revenues for the calendar year of £16.3bn were up 6% on an organic basis and 9% when including acquisitions and currency changes. Profit before tax rose 25% to £1.07bn and at the reported basis was back in the black to the tune of £4.9bn from the £4.6bn loss the year before.

Chief executive Warren East's transformation programme over the past two year, which has seen many hundred of jobs cuts and is expected to see many more, achieved £200m of run-rate savings, which was at the top end of guidance.

Earnings per share rose 27% to 40.5p and on a statutory basis flipped into positive territory at 229.4p. The dividend, which is paid via issuing C-shares, was held at 11.7p.

Results were mostly much stronger than the City expected with the average analyst forecast pointing to underlying profit of £878m, EPS of 34.8p and a 12p dividend.

Free cash flow, possibly the key metric for Rolls-Royce, more than doubled to £273m, way ahead of the consensus estimate of £129m. Net debt also more than doubled to £520m.

For 2018, revenues is guided as growing by mid-single digits, with group operating profits growing £300-500m and FCF £350-550m, including the costs from the Trent 1000/900 issues. The acquisition of ITP Aero, which was completed in December, is expected to grow underlying revenue by double-digits from the €827m last year, but a modest decline in underlying profit from he €75m.

In January, East announced a new strategic development to reduce to three business units based around Civil Aerospace, Defence and Power Systems, while putting the Commercial Marine unit under review.

On Wednesday he expanded on this: "As I look to the year ahead, we are embarking on a more fundamental restructuring programme with a refreshed leadership team and an improved market environment."

He said the new business structure will provides Rolls-Royce with a clearer focus on customers and markets, provides "the potential to drive sustainable long term free cash flow towards our mid-term ambition of around £1bn by around 2020 with further growth over the subsequent years".

The restructuring will move the business to a "considerably simplified staff structure, with fewer layers", with restructuring experts Alvarez & Marsal retained to support a programme East expects to deliver a "significant reduction" in costs and help improve performance. He promised to "provide clarity of these benefits" later in the year.

REACTION & ANALYSIS

Rolls-Royce shares rose 13% to 937p my mid-afternoon on Wednesday, their highest level since November.

UBS said a strong power system and better than expected civil aerospace revenues were behind the revenue and profit beats, while the company's 2018 FCF guidance of £450m +/- was circa 11% ahead of consensus.

It noted that under IFRS15, revenues would have been £1.4bn lower, and profit £854m lower, with the impact concentrated in Civil Aerospace.

Barclays said: "FCF is widely seen as the only way to value Rolls given the significant IFRS 15 adjustments" and noted that while there was a strong cash beat in 2017, in the context of a £15.4bn market cap company this was seen as "unlikely" to be the driver for the shares, with the 2018 cash guidance "looks good" though it was excluding the contribution of ITP, which would make it much closer the cons estimates of around £400m.

"This does however include heightened costs on the Trent 1000 and Trent 900 programmes to the tune of ~£300m [...] which should be taken as a positive."

Citi said it was a "good set of results", adding that investors "need to look further out" than 2017 or even 2018 forecasts. "We continue to believe in the improving narrative and reiterate our 'buy'."