Rolls-Royce strategy bind is a problem best shared

Rolls-Royce's flight path to financial wellbeing contains gathering cost clouds. The $13 billion aero-engine maker saw its shares surge by a fifth on Thursday as it beat expectations for 2022, after a year blighted by an acute aviation sector recession. But new Chief Executive Tufan Erginbilgic still has a problem. Having prepared investors for the worst by recently describing the 117-year-old company as a “burning platform”, Erginbilgic pleasantly surprised them by disclosing 505 million pounds of free cash flow last year, fuelled by a 35% growth in large engine flying hours. That’s way better than the 1.5 billion pound cash outflow in 2021, but also four times what analysts had expected. Even so Rolls, which makes 45% of its revenue from making, selling and servicing commercial aircraft engines, is on the wrong side of the energy transition.


Aviation accounts for about 2.5% of global carbon emissions, with most aircraft powered by kerosene. Rolls focuses on wide-body jet engines used in long-haul flights, the hardest to decarbonise. Deploying low-carbon Sustainable Aviation Fuel offers a stopgap solution to slashing emissions in the short term. But reaching net zero emissions by 2050 may involve ditching gas turbines entirely. Unfortunately, it’s not obvious which new technology to bet on. Batteries can only be applied to the shortest journeys. One solution could come from hydrogen-powered fuel cell engines - Rolls clinched a partnership with easyJet in July to carry out a joint project to test a hydrogen engine. Still, the technology remains in its infancy and currently looks better suited to short-haul flights.


Erginbilgic could tap investors. But with Rolls’ share price down about 66% since 2014, they might not welcome a rights issue. And the company’s 3.3 billion pound debt pile and lack of an investment-grade credit rating militates against further big debt financings. The least-bad option is to forge strategic alliances with big aircraft makers like $123 billion Boeing. Rolls’ competitors General Electric and Safran already teamed up with $103 billion Airbus to pioneer the technology behind the world's first zero-emission commercial aircraft, expected by 2035. They also trade on 14 and 16 times 2022 EBITDA, comfortably above Rolls’ 11 times. If Erginbilgic wants to further douse the flames on his burning platform, he needs to pick up the phone.

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Rolls-Royce announced a 57% rise in underlying operating profit to 652 million pounds on Feb. 23. New Chief Executive Tufan Erginbilgic said he would unveil the outcome of a strategic review in the second half of the year. He said that his transformation programme was already underway but major improvements were needed to secure the future of the company. Rolls-Royce’s plans to reach net zero emissions by 2050 date back to 2021. Former boss Warren East had lifted research and development spending on low carbon and net zero technologies as well as sustainable aviation fuel. As of 1008 GMT Rolls-Royce shares were trading at 128 pence, up 19%.

Endless Possibilities

Source: Reuters

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