Rolls-Royce: new captain plots course to higher profits

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A mother’s response when a child declares they want to become a pilot when they grow up? You cannot do both.

Joking aside, maturity problems have plagued UK aero-engine maker Rolls-Royce for years. Chief executive Tufan Erginbilgic, in the job since the start of the year, promises to bring discipline. Wednesday’s profit upgrade sent shares higher by as much as 20 per cent.

Erginbilgic has been scathing in his diagnosis of Rolls-Royce’s problems. He claims it has suffered from decades of mismanagement and a culture unfit for a modern industrial leader. Profit margins from making and servicing jet engines are well below where they should be.

Favourable trends in aerospace markets are putting the wind under the wings of Erginbilgic’s turnaround. Rolls-Royce said that full-year underlying operating profits were now expected to be in the region of £1.2bn to £1.4bn. That is as much as two-fifths more than analysts had been expecting.

The boom in travel and tourism pushed up volumes for Rolls-Royce’s civil aviation division. Note that GE has just reported an almost 30 per cent increase in its aerospace revenues in the first half of the year.

More planes flying means more cash coming in. Rolls-Royce is also touting higher profits from cost savings and contract renegotiations. Unprofitable agreements were valued at £1.6bn at the end of 2022. More clarity on both profit drivers should be given at next week’s results.

Rolls-Royce shares have now doubled since the start of the year. The upgrade leaves them trading at 24 times this year’s earnings. But Rolls-Royce is barely making a low teens operating margin from its engines. Those of its peers are in their high teens.

A 16 per cent margin would add more than £700mn to operating profits for 2025, which translates into an 11 times price/earnings ratio. In the past decade, shares have only traded that cheap during crisis times. Market tailwinds and Erginbilgic’s adjustments both support the flight trajectory.