Rolls-Royce: bold targets keep engine maker flying

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The turnaround plan at Rolls-Royce is picking up speed. The UK aerospace group was hurt badly by the pandemic and the problems with its Trent 1000 engines. Its newest pledge is to add £2bn to operating profits by 2027, quadrupling the £0.65bn it reported in 2022. This looks more credible than past efforts.

The plan hinges on Rolls-Royce’s civil aerospace division. This is the largest of its three businesses, in revenue terms. It accounted for 45 per cent of the group’s £12.7bn of underlying revenues in 2022, with defence and power generation making up the rest.

But civil aerospace makes wafer-thin operating margins, just 2.5 per cent in 2022. A plan to lift this to 15-17 per cent should deliver the bulk of the planned ebit uplift. 

This looks feasible. Rivals such as Safran and General Electric make 18 per cent in this segment, says Nick Cunningham at Agency Partners. However, unlike Rolls-Royce, they benefit from making higher-margin engines for narrow-body planes.

One reason why Rolls-Royce’s margins have been so poor is that — as a challenger trying to build market share in widebody aircraft — it has aggressively priced its new engines. Instead, profits come from service contracts. 

A more rational approach is required. Rolls-Royce has achieved reasonable scale; less discounting is needed. Meanwhile, ageing aircraft fleets will need more service and maintenance, improving its revenue mix.

Rolls-Royce has also signalled that it wants to lop off £400mn-500mn from the cost base and cut up to 2,500 roles. Investors may well look on with scepticism. Previous attempts to bring the sprawling legacy business under control have proved shortlived. On the plus side, new chief executive Tufan Erginbilgic is tough. Plus the business has recently suffered a near-death experience, enabling needed cultural change.

Investors have marked the stock up 80 per cent in the past six months on hopes that Erginbilgic can get his plans off the ground. Yet the group still trades at a one-quarter discount to rival Safran on 2025 earnings. If he delivers his targets, Rolls-Royce can close this gap.

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