Rolls-Royce: tail winds support new chief executive

Chief executives tend to accentuate the positive. Not Tufan Erginbilgic, the new boss at Rolls-Royce. He has railed about potential disaster ahead for the engineering group. That is, if his actions are not heeded.

Erginbilgic took no cheer from last year’s performance, preferring not to credit predecessor Warren East’s efforts. The aero-engine maker smashed expectations at results on Thursday. Operating profits of £527mn last year were 40 per cent higher than analysts’ consensus. Shares rose as much as 25 per cent in response.

But taskmaster Erginbilgic demanded more, including better shareholder returns and lower debt. Start with civil aerospace, responsible for jet engines and Rolls-Royce’s key division. Rarely positive operating margins, even before Covid-19, will need at least to catch up with rival Pratt & Whitney’s, about 5 per cent.

Productivity is another issue in this unit. Rolls-Royce earns $395,000 in revenue per employee, while Pratt & Whitney generates half as much again. General Electric’s jet business makes even more.

Erginbilgic own review is intended to cure underperformance across the board. Staff numbers are likely to be cut further. Iterative restructurings have failed to crack a culture that may be stuck in its public sector roots.

At least Rolls-Royce’s finances are perking up. The outlook for this year assumes flying hours returning to 80 per cent to 90 per cent of 2019 levels. Expected group free cash flow of £600mn to £800mn would go some way to reducing net debts of £3.3bn. If all of that cash went to improving the balance sheet net debt would still exceed expected ebitda of £1.7bn by the end of 2023, but it is more manageable than years past.

All this is needed to regain, eventually, an investment grade credit rating. A tidier balance sheet can then be put to work to crack the industry’s dilemma: decarbonising air travel. A renewed capital focus on the core business could be required.

Any portfolio review means a hard look at the logic of continuing with the small nuclear reactor programme. Big investment, long cash-generation lead times and the vagaries of UK government spending plans mean Erginbilgic must think carefully about its future.