AAfter new Chief Executive Tufan Erginbilgic’s dramatic description of Rolls-Royce as “a platform on fire”, the actual figures for 2022 were almost encouraging – or at least better than anticipated. In place of the previously promised ‘modest’ positive cash flow, Derby’s best engine maker produced £505m, which is no small change even in the context of a group of that size.
Meanwhile, commercial aircraft are flying again, especially in China, which is critical for Rolls-Royce. And obviously it’s a good time to have a defense business. With the share price rising by a fifth on Thursday, one might wonder why Erginbilgic felt the need to ramp up the rhetoric. Shouldn’t he have spent more time thanking the efforts of his predecessor, Warren East, who really had to get the fire hoses out when the pandemic wiped out Rolls’ revenue from engine maintenance?
Erginbilgic’s response on this point was twofold. First, he was trying to increase the workforce. Fair – that’s the prerogative of a new boss. Second, and more pertinently, Rolls’ financial performance is still a shock if you look at the longer term. On that point, he is undoubtedly correct. Nobody had fun in the pandemic, but not all rivals produced a five-year shareholder return of minus 67%. And an average annual return on equity of 4% is a road to ruin if, like Rolls, you’re borrowing on debt that isn’t yet investment grade.
So yes, a full blast on the trumpet of transformation was in order. The goal is “significantly higher profits, cash flows and returns”.
The tricky part is making it happen. The perception that Rolls is “capable of so much more” is nothing new. Go back to East’s opening speech on arrival in 2015, a period after a series of profit warnings, and you’ll find similar simple-speaking refrains. The conversation then turned to making “fundamental changes” in the company’s way of working and injecting “greater pace and responsibility into decision-making”.
Erginbilgic’s seven “workflows” for self-improvement don’t sound all that different in spirit. It’s OK, for example, to say you want to improve “business optimisation” and be properly rewarded for “the value we create for customers”, but who doesn’t? Those same customers, it is assumed, will also be aware of their leverage in negotiations. In a similar vein, the aim of delivering a “significant and structural” reduction in working capital has been heard before at Rolls.
If there’s a difference in Erginbilgic’s approach, it’s the promise to make the strategy “granular”. There may also be a certain new cruelty to cutting programs with marginal returns. The UK government, for example, should take note of the demand to actually commit to a financing model for small modular nuclear reactors, a deal that has excited the East.
However, the ambition will only start to feel real when Erginbilgic sets hard targets for Rolls’ financial ambitions and comes up with some numbers of what he thinks is possible. That moment is promised for the second half of this year and is the first critical step in this latest reinvention effort. He’s still not there.
The good news for shareholders is that gentler breezes are blowing in the aerospace sector, where the civil side accounts for 45% of Rolls group revenues of £12.7 billion. The moment of maximum danger of pandemic consequences has clearly passed if the prediction is correct that engine flight hours in 2023 will be 80% to 90% of 2019 levels.
But investors can, for now, curb their enthusiasm for the idea that the Rolls can smoothly move onto a higher glide path. The aerospace business remains capital intensive and volatile; and net zero appears to pose as many threats as it does opportunities. A comprehensive review of operations is warranted at this point and Erginbilgic is saying the right things – but he’s not the first to promise the future will be better.