Rolls Royce Earnings: Strong Set of Results, Guidance Update

Narrow-moat Rolls-Royce RR. upgrades full-year guidance for operating profit and cash flow, on the back of a strong set of results for first-half 2023, with a historical record-high group profit margin driven by civil aerospace performance. Although engine flying hours are still at 80% of 2019 levels, civil aerospace operating margin increased at 12.4% versus a negative 3.4% in first-half 2022 on the back of higher percentage of spare parts sales, cost efficiencies, increased time on wing, and price optimization.

Results confirmed that some of the structural improvements, mostly related to price contracts renegotiation, that we had forecasted to take place by 2025 were delivered ahead of schedule. This timing difference, however, has limited affect on our medium-term forecasts, and hence, we are maintaining our GBX 223 fair value estimate for the stock.

Defense sales increased by 15% organically versus first-half 2022 driven by defense budgets expansions in most Western geographies. Operating margin increased from 11.7% in first-half 2022 to 13.6%, driven by pricing actions, cost efficiencies, and a higher percentage of spare part sales.

In the power generation business, revenue growth was up 24%, driven by strong sales of power solutions in both marine and mining, while margins were lower than in first-quarter 2022 because of the negative impacts of both product mix and higher costs. Given the seasonality of the business and the positive impact of implemented pricing actions, margins for the segment are expected to increase in the second half of 2023.

Cash flows improved from a negative outflow in the previous period to a positive inflow, primarily driven by improvement in operating profit.