Rolls-Royce might be keen for investors to see the group as a more multi-faceted operation, but the devastation caused by the grounding of airline fleets last year means that investors would be foolish not to have the civil aerospace business front and centre of their minds. A slump in travel has sapped revenues for the engineering specialist’s main division.
A key target to generate free cash of £750 million by 2022 has been pushed out, although the group still expects to turn free cashflow-positive during the second half of this year.
Under its engine servicing model, Rolls charges customers a fixed amount on a “per flying hours” basis. If cash-strapped airlines have had much of their fleets grounded, then they’re hardly going to be spending on new engine orders, either. Revenue earned from international flights makes up about three quarters of the civil aerospace total. Large-engine, long-term service agreement flying hours have improved, but are only 43 per cent of the 2019 level, up from 34 per cent during the second half of last year. Rolls needs engine flying hours to exceed 80 per cent of the pre-pandemic level to hit its £750 million free cashflow target in the following 12 months.
You would think that there would be little to cheer, but investors sent the shares up by nearly 6 per cent in response to first-half figures. There are two probable reasons: one, that the market was already sceptical that Rolls would hit its target — analysts’ forecasts for 2022 free cashflow have been below £600 million since last September; and two, that management’s damage limitation efforts have allayed fears that the balance sheet is in imminent danger.
In fact, Panos Kakoullis, the chief financial officer, says that engine flying hours could remain at present levels and Rolls would have enough liquidity to maintain its operations for the foreseeable future. After extending a £1 billion unused loan facility this week, it has no debt maturing before 2024, but that doesn’t mean that £3.1 billion of debt, excluding lease liabilities, isn’t a problem. Top of the list of priorities is reducing leverage and trying to get an investment grade credit rating.
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A huge cost-saving programme has played a big part in reducing cash outflows, which even at £1.17 billion were better than analysts had expected. It’s almost done, with 9,000 job reductions and 11 civil aerospace sites cut to half a dozen. It hopes to reduce its costs by about a third.
News on disposals has piqued hopes, too. The day before these results, Rolls said that it had agreed a sale of Bergen, its marine engines business, for an enterprise value of €63 million. But the big-ticket item is ITP Aero and talks are progressing with a consortium for a €1.6 billion sale. So the group isn’t teetering on the brink. The defence and power systems businesses haven’t been without their issues, but they have been revenue generators, too.
The question then turns to longer-term growth. The flight path there might not be clear, either. Even if the trend for Zoom meetings translates to a small percentage of business travellers leaving the market, it could mean that “these airline customers have a tougher journey to recover their own profitability”, according to Rory Smith, of Investec. That could affect civil aerospace revenue over the medium term.
The return of international flying is the most obvious catalyst for the shares to rerate, although that is naturally laden with uncertainty. A forward enterprise value of just over nine times earnings before interest, taxes and other charges is above the five and ten-year average multiples and is in the same ballpark as a pre-pandemic valuation. That looks too optimistic.
Advice Avoid
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Why Risks around the return of international flights and high debt are not reflected in the shares’ valuation
Savills
A frenetic housing market that coincided with weaker GDP and rising unemployment was one of the bigger economic absurdities that occurred during the pandemic. For estate agencies such as Savills, it made what should have been a crushing 18 months more bearable.
The FTSE 250 group expects its full-year performance to be “meaningfully” ahead of previous expectations. Numis, the broker, upgraded its pre-tax profit forecasts for this year and next by 24 per cent and 12 per cent, respectively.
The boom in the housing market that followed the stamp duty break helped to boost transaction advisory business by 11 per cent in the first six months of the year. Commercial business has been slower to return, with cross-border deals harder for those without boots on the ground in multiple countries. Big global investors, such as Blackstone, the private equity firm, have provided much of the activity, but corporate transaction revenue over the first six months of the year was 15 per cent higher than the 2020 level and almost in line with 2019.
With retail property valuations heading through the floor and uncertainty over how much office space will be needed after the pandemic, investors would be right to reserve judgment on whether the growth rate in transaction advisory revenue can be sustained, especially so given that housing market activity is expected to return to more normal levels this year.
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However, it also means that while the higher-margin dealmaking side of the business might have got more attention, the non-transaction businesses are more deserving of credit. Property and facilities management revenue, which accounts for just over a third of the group total, has been steady fuel for the top line. Even empty — or half-empty — buildings need someone to keep an eye on them.
The breadth of Savills’ services means that identifying peers on the market is difficult. It rightly trades at a premium to most other estate agencies, but even compared with its own history the shares look expensive — a forward earnings multiple of almost 17 is towards the top end of the post-referendum range.
Advice Hold
Why Prospects accounted for in a toppy valuation
