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Atlantic View – Rolls Royce has the tools to engineer a recovery

by John Woolfitt, Atlantic Capital Markets

Rolls Royce has the tools to engineer a recovery.

Fundamentals & Statement Summary

Aero engineering giant Rolls-Royce (RR.) this morning unveiled interim results for H1 2020, and reported a significant H1 impact from COVID-19, adding that the timing and shape of industry recovery remains uncertain. The group reported a 24% fall in underlying revenues of £5.6bn, down 24%, and an operating loss of £1.7bn including one-off charges of £1.2bn in Civil Aerospace, largely related to COVID-19. The reported loss before tax of £5.4bn included a £2.6bn non-cash loss from the revaluation of the FX hedge book, reflecting lower forecast US$ receipts.

Rolls also reported good liquidity of £6.1bn comprising £4.2bn of cash at 30 June, and a £1.9bn undrawn revolving credit facility (RCF). A further £2bn undrawn term loan  was also announced in July and finalised in August. The group ended H1 with net debt of £1.7bn excluding lease liabilities (FY 2019 net cash of £1.4bn).

The group reported successful actions to reduce costs, with £350m delivered in H1 towards a 2020 target of £1bn. These actions included a fundamental restructuring of Civil Aerospace, with a 4,000 group headcount reduction by 27 August, with further potential disposals expected to raise at least £2bn, including ITP Aero and other assets.

The Board decided that given the uncertain macro outlook they would no longer be recommending a final shareholder payment of 7.1 pence per share in respect of 2019, resulting in cash savings equivalent to £137m. For the same reasons, the Board has not approved an interim shareholder payment for 2020. A range of options to further strengthen the balance sheet are currently under review.

CEO Warren East commented: “We ended 2019 with good operational and financial momentum. However, the COVID-19 pandemic has significantly affected our 2020 performance, with an unprecedented impact on the civil aviation sector with flights grounded across the world. We have responded rapidly to increase our liquidity, with £6.1bn at the end of H1 and a further £2.0bn term loan agreed in H2, to help weather the continued uncertainty around the timing and shape of the recovery in the civil aviation sector. We have made significant progress with our restructuring, which includes the largest reorganisation of our Civil Aerospace business in our history. This restructuring has caused us to take difficult decisions resulting in an unfortunate but necessary reduction in roles. These actions will significantly reduce our cost base, which combined with recovery in Power Systems and continued resilience in Defence, will help us to deliver significantly improved returns as the world recovers from the pandemic.

While our actions have helped to secure the Group’s immediate future, we recognise the material uncertainties resulting from COVID-19 and the need to rebuild our balance sheet for the longer term. We have identified a number of potential disposals that are expected to generate proceeds of more than £2bn, including ITP Aero and a number of other assets. Furthermore, in light of ongoing uncertainty in the civil aviation sector, we are continuing to assess additional options to strengthen our balance sheet to enable us to emerge from the pandemic well placed to capitalise on the long-term opportunities in all our markets.”

Chart and Technicals

Source: FactSet and Hargreaves Lansdown

In line with aerospace industry stocks and the majority of FTSE100 constituents, RR shares fell sharply through February and into March, twice bouncing off a 250p then multi-year low. Despite recovering and punching back above the 50-day moving average in May, the stock succumbed again at the start of July, trading below the yellow MA envelope, even briefly dipping below 250p to set a new multi-year low at 212p before recovering in the run up to the results. The NVI (negative volume index (traded volume to determine trend strength or confirm a price movement) has improved since the end of June, and if RR can ‘climb back’ into the price range envelope after the results today, and in the process regain the 50-day moving average, then recovery of the falling 200-day MA is possible, although expect a retest of 212p multi-year lows before any sustained recovery.

Summary and Atlantic View

While it’s aerospace counterparts face something akin to a perfect storm, as a corporate entity Rolls Royce has many more strings to its proverbial bow. It is this multi-sector offering that will ultimately be the saviour of this iconic company, and while the group are rightly hailed as the world’s leading aero engine manufacturer, a solid cash / liquidity position has enabled Rolls Royce to pivot rapidly to meet the COVID challenge. A resilient ongoing defence business performance and a recovery in Power Systems provide Rolls with the time to decide on the best course of action to restructure and streamline the aerospace business, and with actions / disposals already underway in this regard, the catalysts will soon be in place to drive a recovery. The decision to suspend the dividend will no doubt see some investors look elsewhere, but despite COVID uncertainties, Atlantic believes Rolls Royce has the tools at its disposal to engineer a decent recovery in the share price by December 2020. We recommend buying the shares on the current weakness.

To take advantage of this trading idea, speak to a member of our dealing team on 01872 229000 or visit the Atlantic Capital Markets website here

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