# Rolls-Royce Holdings strong foundation to deliver better returns

- Link: https://www.directorstalkinterviews.com/rolls-royce-holdings-strong-foundation-to-deliver-better-returns/412947147
- Published: 2020-12-11T07:16:00+00:00
- Author: Amilia Stone

**Rolls-Royce Holdings** **plc** (LON:RR) has announced its latest trading update.

·      Restructuring plans on track to deliver our targeted £1.3bn cost savings 
by 2022; at least £1bn of near-term cash cost mitigations confirmed for 2020

·      Power Systems end markets seeing some early signs of improvement

·      Defence remains resilient with strong order cover for 2021

·      Civil Aerospace large engine flying hours gradually recovering; year-to-date
42% of 2019

·      £5bn package completed in November to increase resilience, strengthen the
balance sheet and support long-term strategy

·      Expected 2020 FCF of approximately £(4.2)bn, subject to timing of year-end
working capital cash flows; resulting in year-end net debt £1.5bn – £2.0bn and liquidity
£8.5bn – £9.0bn

·      Guidance unchanged: we expect to turn cash flow positive at some point during
H2 2021, target at least £750m free cash flow (excluding disposals) as early as 
2022 and at least £2 billion from disposal proceeds

> **Warren East, CEO, said:** “We have taken decisive actions to protect and reposition
> our business in difficult and uncertain trading conditions, including the impact
> from a second wave of COVID-19. We have made rapid progress on our restructuring
> programme and the consolidation and reorganisation of our Civil Aerospace footprint
> is well underway. Our £5 billion recapitalisation package in November was well
> supported and has increased our resilience and strengthened our balance sheet.
> The outlook remains challenging and the pace and timing of the recovery is uncertain.
> However, our actions have given us a strong foundation to deliver better returns
> as our end markets improve and we continue to drive our ambition of delivering
> more sustainable power to support the creation of a net zero carbon economy.”

**Trading update for 11 months to end November**

Prior to COVID-19 we were reaching a pivotal point in Civil Aerospace. Following
a period of rapid growth and new engine programme launches, R&D investment demands
were falling and returns improving as we began to benefit from our large and growing
installed base and reduced losses on new installed engines. The benefits from this
have been delayed due to COVID-19, but the fundamental drivers of having a more 
efficient business with stronger margins and better returns remain intact and position
us well for the eventual rebound.

In the 11-month period to end November, large engine LTSA invoiced flying hours (
EFH) were approximately 42% of their prior year level. EFH have gradually improved
since the trough in April although more recently the pace of recovery has slowed
due to the second wave of infections in some geographies. In October and November
combined, EFH increased to approximately 33% compared to 2019. In Q3 our EFH were
29% of the prior year, an improvement versus the 24% seen in Q2. We have reduced
the pace of production for our large engines and our full-year guidance for approximately
250 deliveries is unchanged.

Business aviation has continued to see less of an impact than scheduled commercial
flights with flying hours holding up relatively well, despite border restrictions
being in place in many parts of the world. 

Our Defence business has remained resilient with good cash conversion. We have a
strong order book and 2021 forecast sales are well covered. In recent months we 
have secured orders for 56 new EJ200 engines for the German Air Force and reached
an agreement to provide in-service support for the T-55 engine, should it be selected
as the future heavy transport helicopter of the German Bundeswehr. We continue to
focus on key growth opportunities for our core products in the US and the UK. The
recently announced multi-year Defence budget increase in the UK will provide additional
investment for next generation capabilities, such as the Future Combat Air System
where we are a core partner in the growing Tempest programme. In addition, we are
innovating in adjacent products and growing our aftermarket revenues from our large
installed base.

Power Systems has experienced a significant fall in demand in most non-governmental
end markets this year. The activity declines seen in the second quarter caused by
the pandemic continued into the second half of the year, except in China where economic
activity has recovered more quickly and we have continued to grow our market share.
In recent months, we have seen some early indications of order intake levels picking
up and year-to-date our net book:bill ratio has been approximately 1x. In November,
at the China International Import Expo, we announced provisional agreements with
six Chinese companies for almost 1,000 MTU engines and systems.

Our Small Modular Reactor (SMR) consortium has signed strategic agreements with 
Exelon Generation and CEZ and the UK Government has committed £215m for a four-year
development plan for SMRs. This highlights the appeal and opportunities of our nuclear
energy solution to support the decarbonisation of power generation in the UK and
abroad.  

In line with the challenging Civil Aerospace market trends, ITP Aero has seen a 
continued negative impact on trading. Defence, which represents 25% of ITP Aero 
volumes, benefited from the Eurofighter order from the German Airforce for 56 EJ200
engines.

**Taking actions to protect our business**

The pandemic is causing a reduction in demand for our Civil Aerospace products and
services that we expect will take several years to recover and as a result we announced,
on 20 May, a major reorganisation programme. We have made good progress towards 
our target for £1.3 billion of pre-tax cash cost savings and a reduction of at least
9,000 roles by the end of 2022. More than 5,500 roles will have been removed by 
the year end, ahead of our prior expectation of over 5,000, with a significant proportion
achieved through voluntary severance. We are in consultation regarding the next 
phase of our Civil Aerospace footprint review, which includes a proposal to transfer
our facility and workforce in Hucknall, UK, which manufactures a range of aero-engine
parts, into ITP Aero. We are also proposing to consolidate the manufacture of aero-
engine structures into ITP Aero. These difficult but necessary decisions will help
generate efficiency savings for the Group and strengthen ITP Aero’s capabilities.

Our mitigating actions to preserve cash in 2020 are on track to deliver more than
£1 billion of in-year savings in 2020. We expect approximately £4.2 billion free
cash outflow in 2020, reflecting the impact of the second wave on flying hours in
the fourth quarter. The actual outturn will be influenced by the timing of significant
working capital cash flows around the year-end, in particular for original equipment
concession payments which depend on the timing of new aircraft deliveries to airlines.

Rebuilding our balance sheet and increasing our financial resilience are key to 
our ability to position our company for the future. Our £5 billion recapitalisation
package, completed in November, comprised £2 billion of new equity, £2 billion in
new bonds with maturity in 2026/2027 and a £1 billion 2-year bank facility that 
remains undrawn. This extended and replaced shorter term facilities including an
undrawn £1.9 billion revolving credit facility which was cancelled when the new 
financing was finalised. As a result, we expect to end the year with net debt of
between £1.5 billion and £2.0 billion, excluding lease liabilities of approximately
£2.1 billion, and liquidity between £8.5 billion and £9.0 billion. 

**Disposal update**

In December we signed an agreement to sell our civil nuclear instrumentation and
control business, the first of a number of disposals that we have under consideration.
This transaction is expected to conclude in the second half of 2021 and contributes
towards our target of generating at least £2 billion from disposals, as announced
in August.  Other assets under consideration for disposal include ITP Aero and our
medium speed gas and diesel engines business, Bergen Engines.

**Looking forwards**

As we look ahead, we are confident in our plans to position the business for the
recovery as we deliver our reorganisation programme in Civil Aerospace to align 
to future demand and realise the opportunities for future growth as our end markets
recover. The fundamental drivers behind long-term growth in global commercial flights
remain intact.  

While many of our end markets continue to be significantly affected by COVID-19,
we will continue to actively respond to any changing timing of recovery and the 
recent news on effective vaccines is encouraging. Commercial air travel looks likely
to recover slowly in the first half of 2021, reflecting the reduced winter schedules
planned by the airlines and continuing the trends seen in the second half of 2020.
We anticipate an improvement in the second half of 2021 as vaccination programmes
support the further reopening of borders and economic recovery.

We continue to expect the Group to turn cash flow positive at some point during 
the second half of 2021, as we mitigate the uncertainty of the timing and shape 
of the recovery through cost-saving and capital allocation actions. Our target to
deliver at least £750 million free cash flow (excluding disposals) as early as 2022
is also unchanged.

**Trading update conference call at 09:00 (GMT) today**

UK dial-in: 0333 300 0804 / US dial-in: +1 631 913 1422 / International dial-in:
+44 333 300 0804

Participant passcode: 7893 9687#

A replay will be available shortly after the call has concluded

UK dial-in: 0333 300 0819 / US dial-in: +1 866 931 1566 / International dial-in:
+44 333 300 0819

Participant passcode: 3013 34996#

Rolls-Royce Holdings 2020 Full Year results announcement will be published on 11
March 2021.

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