Analyst Note| Joachim Kotze |
Narrow-moat Rolls-Royce experienced free cash outflows of GBP 4.2 billion in 2020 as the group reported an underlying EBIT loss of GBP 2 billion mainly due to losses in the civil aerospace segment as a result of the coronavirus pandemic. Besides lowering the outlook for the recovery in engine flying hours, or EFH, to 80% of 2019 levels by 2022 from 90%, not much has changed since the trading update in January. Management still expects free cash outflows of GBP 2 billion in 2021, on the back of 2021 EFH at 55% of 2019 levels, and a recovery to free cash flows of GBP 750 million by 2022. The key driver to a return to profitability and a cash flow positive position is the recovery in wide-body flying hours and the successful execution of the group’s GBP 1.3 billion civil aerospace cost restructuring program. We expect organic revenue to recover by 2024 and EBIT margins to normalize at 10.4%, in line with the group average before the onset of the Trent 1000 engine issues. We will make slight changes to our near-term forecast as we update our model, but don’t expect any material change to our GBX 95 (ADR: $1.20) fair value estimate. Shares appear overvalued, while the cyclical and structural recovery story is riddled with uncertainty. Wide-moat peer Safran offers a more attractive risk/return profile in our view.