Four years ago, Rolls-Royce was forced to ask shareholders for money and cut 9,000 staff to weather the downturn brought on by the Covid-19 pandemic.
Last week, Britain’s flagship engineer reported a 74 per cent jump in half-year profits, a resumption of dividend payments and a gift of 150 shares per employee, marking one of the most remarkable and rapid turnarounds in recent UK corporate history.
The sharp shift in its fortunes coincided with the arrival of Tufan Erginbilgiç, who took the controls in January 2023. Shares in Rolls-Royce have more than quadrupled over that time, outperforming most major indices.
The company’s turbocharged performance means that it is already more than halfway towards annual profit and cash flow targets set by Erginbilgiç for 2027; Rolls-Royce now expects to deliver more than 75 per cent of its target of up to £2.8bn in annual operating profit and more than 65 per cent of its goal of up to £3.1bn free cash flow by the end of this year.
Although his predecessor, Warren East, successfully steered the company through the depths of the pandemic, Erginbilgiç, who described Rolls-Royce as a “burning platform” when he joined, has moved quickly to shake up senior management, reduce duplication and cull middle managers.
The rapid transformation of the 118-year-old manufacturer, whose recent history has been marked by sharp swings in fortune, has raised questions over how long Rolls-Royce’s current winning streak can last. Can the former oil industry executive deliver on his promise to turn the company into a “high-performing, competitive and resilient business”?
Erginbilgiç admitted that the rate of recovery would not be linear but argued that the group’s midterm targets should be seen as a “milestone, not a destination”.
“There is a very exciting, more profitable growth story beyond the midterm,” he said.
He dismissed suggestions that part of the recent success was down to the return of international air traffic following the pandemic, which all but halted travel. Rolls-Royce’s biggest division builds engines for the world’s largest passenger aircraft but makes most of its money from servicing and maintaining these while they are in service.
“This is not a flying hours story, that question should disappear,” he said. The company, he argued, was instigating real change, reducing costs and expanding the “cash potential and quality of the civil business”.
Rolls-Royce has renegotiated lossmaking contracts with customers to lift profitability and will invest more than £1bn over the coming years to improve the durability and performance of its Trent family of engines which power long-haul passenger planes such as Boeing’s 787 and the Airbus A350.
Analysts said the performance of the civil business in the half-year stood out. Engine flying hours, a key metric given the company makes most of its money when its engines are in operation, were back to pre-pandemic levels while margins in the business had risen 18 per cent over the six months.
The new management had “squeezed more out of the upside than people expected . . .[they] got more out of it than the old Rolls-Royce would have done”, said Nick Cunningham, analyst at Agency Partners.
The “structural change”, he added, “is partly about the company being more tightly run with a clear set of guidelines as to what they are trying to achieve”.
Company insiders talk about the “pace and intensity” Erginbilgiç has brought to the business, much of it evident in the rigorous, regular reviews he holds with senior managers, where clear targets are set.
He had instilled a “sense of commercial-mindedness . . . not only through civil but throughout the entire organisation and [has] kept the costs out that the company had taken out during Covid”, said Harsh Jhaveri, investment analyst at Orbis Investments, which bought into Rolls-Royce in 2016 and owns 0.5 per cent of the company.
While much of the focus has been on the improvement in Rolls-Royce’s commercial aircraft division, its other businesses have also rebounded. The underperforming power systems unit — which makes diesel and gas engines for ships, as well as power generators for data centres — has recovered.
Last week’s half-year results showed that the division’s underlying operating profit grew by 56 per cent to £189mn. Its underlying operating margin rose to 10.3 per cent, with expectations of further improvement in the second half.
In the defence unit, Rolls-Royce has notched up some notable contract awards and should benefit from higher government spending, including on the Aukus submarine programme with Australia and the US.
In the medium term, the big challenge strategically will be how the company can re-enter the lucrative short-haul narrow-body aircraft market. Rolls-Royce left that sector over a decade ago when it pulled out of a joint venture with Pratt & Whitney of the US. The British company recently started work on a demonstrator of its Ultrafan engine, which would be specifically designed to power a next-generation narrow-body jet.
Erginbilgiç said he was talking to Airbus and Boeing about the engine. Rather than developing and building it alone, he would prefer a partnership with another company, he added.
Notwithstanding the company’s strong performance, there are some clouds on the horizon. Industry-wide supply chain challenges could persist for another two years. Rolls-Royce’s cash flow guidance for the year includes an impact of as much as £200mn from supply chain issues.
There are also some early signs of pressure on airline yields, a measure of average ticket prices that takes into account passenger numbers and distance flown. Most aerospace executives insist it is too early to talk about a fall in traffic growth and hence demand, but the biggest test of whether Erginbilgiç’s transformation has paid off will probably come with the industry’s next downturn — and whether he has made Rolls-Royce more resilient.
Most analysts reiterated their “buy” ratings on the company last week, arguing there was more to come despite the shares trading at a multiple of around 25 times next year’s earnings.
Philip Buller, analyst at Berenberg, who downgraded the stock to “sell” at the start of the year, admitted his call came to too early given the 50 per cent plus run-up in the shares since January.
He credited Erginbilgiç and his team for “over-delivering” on cost controls but argued that investors should look beyond 2027. “What happens to cash post-2027 . . . and is there anything else in the interim that could spoil the party, such as air traffic softening?”
The shares, he said, were now priced for “this very nice moment in all end markets to be a permanent feature”. However, “history tells us this is not normally the case”, he cautioned.
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