Rolls-Royce tried to strike an upbeat tone with its trading statement on Thursday. The 115-year-old maker of engines for civil aviation giants Airbus and Boeing said its customers were gradually flying more hours again, earning it more fees than last year under long-term contracts. Rolls said that, added to faster-than-expected savings from a brutal round of job cuts, this meant it would burn less cash than forecast this year.
As so often with Britain’s troubled engineering champion, though, the market was sceptical. Rolls shares fell by almost 3.4 per cent as investors factored in renewed uncertainty over travel restrictions following Boris Johnson’s shambolic imposition of “Plan B” measures to deal with the Omicron variant.
Nick Cunningham, a seasoned Rolls watcher at the research firm Agency Partners, said the analyst call reminded him of Rolls’s results in February last year, when the first Covid wave was about to hit global travel. “We didn’t quite know what it was going to mean, but we had a very bad feeling about it,” he said. “Frankly, Omicron looks like it’s going to be a bit of a disaster, to say the least.”
Sitting in Rolls’s headquarters in King’s Cross, north London, chief executive Warren East seemed relaxed about the red squiggle on traders’ screens later that day. “At the moment, the share price responds in quite a volatile way to daily newsflow,” he said. “When Plan B was announced last night, we knew jolly well what was going to happen to our share price this morning, whatever we said in the trading statement.”
East, 60, has got used to turbulence since he clambered into the Rolls cockpit in 2015, having retired from chip designer ARM Holdings two years earlier. He issued a profit warning on his second day in the job — followed by another before the end of the year, making it five in twenty months. He cleared up the aftermath of a decades-long corruption scandal and pulled Rolls back into the black after a £4.6 billion annual loss for 2016. Then the discovery of cracking turbine blades in its Trent 1000 engines blew his turnaround off course, triggering billions of pounds of compensation payments to airline customers of Boeing, whose Dreamliner jets had to be grounded.
Advertisement
Then came the pandemic. Rolls has laid off 8,500 staff, almost a fifth of its total, and raised £7.5 billion in equity and debt. Some was underwritten by the government, which was “obviously rightly concerned” about the threat to the company whose nuclear reactors power the Royal Navy’s submarines.
Rolls, which now employs 45,000 people around the world — 18,000 of them in the UK, many at its Derby site — is not out of danger: its customers are flying about 50 per cent of the hours they did in 2019. Even that is up from 43 per cent in the first half of the year. East reckons the long-haul market, Rolls’ speciality, will not return to 2019 levels until 2024 or 2025. “Omicron is just part of that,” he said. “There’ll be another mutation of this virus. We’re going to go through a cycle of ten steps forward and two steps backwards.”
Nonetheless, it has stabilised to a point where East can think about the next big challenge: decarbonising flight. Rolls has pledged to make sure all its engines can run on 100 per cent sustainable fuel — the likes of old cooking fat — by 2023, and to make all its products compatible with net zero by 2050. In November, Rolls claimed that a prototype battery-powered plane, Spirit of Innovation, had broken the electric air-speed record by hitting 555.9 kilometres per hour over three kilometres.
Spirit of Innovation is a single-seater set up for that purpose; the test pilot, Phill O’Dell, even had to lose weight like a jockey ahead of the flight.
Rolls has a small stake in Vertical Aerospace, Ovo Energy tycoon Stephen Fitzpatrick’s air taxi start-up, and is developing an electric plane with Italy’s Tecnam and Norwegian airline Wideroe. But “aviation is a hugely difficult application to make net zero”, East admitted.
Advertisement
The Tecnam/Wideroe model will be able to carry about nine people for a hundred nautical miles. Long-haul flights are unlikely to be battery-powered for the foreseeable future. “We can’t see a hybrid or electric-type solution. The maths just doesn’t work based on technology we can envisage for the next 20 years,” East said.
“If we’re taking 300 people to China, say, it’ll have to be using a synthetic form of kerosene because kerosene has the energy density, both in terms of weight and volume. There are grey areas in between. There we could consider hydrogen as a store of energy instead of kerosene. Or we could consider, up to a point, batteries augmented by a gas turbine.”
The numbers are huge in every direction. Rolls’s total carbon emissions, including those of airlines flying Airbus and Boeing jets powered by its engines, were 276 million tonnes in 2019. For context, the entire UK emitted 550 million tonnes. Sustainable jet fuels, let alone more complicated technology, are very costly — up to five times more expensive than normal fuel. (Rolls thinks that cost of sustainable fuel can be driven down to double within a decade.)
East rejected the suggestion that flying could become the preserve of the wealthy, saying it was imperative for the industry to make low-carbon air travel as cheap as the fossil-fuel kind. “Aviation is a good thing,” he said. “Whether it’s goods on the shelves in a shop or infrastructure, how much doesn’t come by air? I can’t think of many examples of human endeavour where you’ve had the sorts of advances we’ve had in flying over the past 100 years where it’s all gone backwards because people have given up or it’s become too expensive. What tends to happen is that technology helps us find ways of solving the problem — typically making things more affordable.”
East said that “nobody can tell you” what the economics of this will look like for aircraft manufacturers. “That’s what we, as an industry, have to work out over the next couple of decades,” he added.
Advertisement
The question for Britain must be whether the company founded by Charles Rolls and Henry Royce in 1906 after a meeting in a Manchester hotel can fund its way through this transition alone. “Decarbonising aviation is going to mean pursuing probably several different technologies at the same time, not knowing which one is going to win — if any — and when you’re going to get a return off it,” said Cunningham of Agency Partners. “That requires a risk appetite that I’m not sure Rolls can afford.”
The company’s market capitalisation has shrunk from £15.7 billion when East took over to £10.8 billion. It is carrying £3.1 billion of debt. American rival GE, which is preparing to break itself in three, is valued at $107.9 billion (£81.6 billion). Raytheon, the owner of another US rival, Pratt & Whitney, is trading at $129 billion. Asked whether it was possible that Rolls could eventually partner with a bigger company to tackle net zero, East said: “Maybe. We’re a business. We’re open-minded to all sorts of things like that.” His response was similar on the topic of single-aisle planes. Rolls is heavily exposed to the “wide-body” models typically used in long-haul travel (East’s predecessor, John Rishton, sold out of a narrow-body joint venture with Pratt & Whitney ten years ago).
Wide-body engine sales collapsed by half in the pandemic. The narrow-body market, more focused on short-haul travel, has recovered quicker. Rolls has been developing an engine suitable for single-aisle jets, UltraFan, but East said there might not be an opportunity to pitch for an Airbus or Boeing narrow-body programme “this decade”. And even “if we were successful in getting designed into a volume product, we don’t have the industrial capacity to service that level of volume. Either we’d have to invest a ton of money or we’d partner with somebody that had the capacity.”
One example of corporate partnering came last month when Rolls joined forces with the US nuclear giant Exelon Generation, France’s Perrodo family and the Qatari state to develop a fleet of small nuclear reactors. The project, which will benefit from £210 million of taxpayers’ cash, will see 16 reactors built across Britain, with the cost falling from £2.2 billion apiece for the first five to £1.8 billion. Although some analysts are unconvinced that nuclear will be able to compete against solar and wind power on price long-term, East said that he was “reasonably bullish” about the business. He said the big opportunity was to install more reactors besides the first 16, servicing private sector clients such as airports and hydrogen generators. “If we do that as well, it could dwarf the size of the Rolls-Royce business today.”
Rolls’s chief executive is a part-time church organist who enjoys a “great wrestle” with a difficult piece of music. His appetite for a musical challenge is matched in his professional life. Having seen the back of one activist, Value Act, last year, East now has another speaking up on his share register. Los Angeles-based Causeway Capital and its portfolio manager Jonathan Eng broke cover in August with the vaguely threatening suggestion that Rolls should “refresh” its board. East said that the two sides had a “difference of opinion” before last year’s rights issue — Eng would have preferred to have sold parts of the business to raise cash instead of issuing equity. But East added: “That’s fine. Shareholders are entitled to their fair opinions . . . And obviously, our efforts are intended to give people like Jonathan a healthy return.”
Advertisement
Despite having a “fantastic job”, East has found the past six years “exhausting”. “It’s been a bit of one thing after another, really,” he said. But he is determined to steer Rolls into a recovery where resurgent revenues on a lower cost base give shareholders the benefit of what is known as “operational gearing”. “We need to see that appear,” he said. “People asked me at the time of the rights issue, ‘Are you going to jump ship?’ I said, ‘No, of course not. I’m committed to making this work.’ We made some promises around our rights issue and I’ll stand by and deliver them.”