As debuts go, Rolls-Royce’s new chief executive has got off to a pretty decent start.
Since Tufan Erginbilgic took up his seat on 1 January the shares have risen 12% to 111p and have now all but doubled since last year’s low point in October.
Of course, Erginbilgic has yet really to do anything other than take occupation of his office.
But if success in business, like comedy, is down to timing the appointment of the former BP man might, at last, have Rolls backers feeling a bit better about themselves after years of disappointment.
Erginbilgic’s first public outing will be the annual results on 23 February, but in the meantime keeping his head down while optimism about the air travel builds looks like a smart move.
And the idea that the airlines are finally over their Covid nightmare is providing a real tailwind for the sector.
Shares in the European carriers have risen by an average of 20% since mid-December, pointing to “what is clearly going to be a much better year than we had previously envisaged”, according to Deutsche Bank.
The bank has just upgraded its earnings forecasts across the sector to reflect ‘the superior operating environment’ and the assumption that strong pricing in the September quarter of 2022 has persisted.
Many airlines also now seem confident enough about the future to dust off plans for a fleet overhaul with the obvious read-through being that plane makers and engine makers are going to see the benefit.
Already there is a global backlog of aircraft for delivery of more than 13,000 at Airbus and Boeing and other smaller makers, many of which will be powered by Rolls-Royce engines.
Rolls’ civil aerospace arm accounted for around 41% of revenue in 2021, defence 31% and power systems 25%, so a rebound in aircraft demand clearly is to be welcomed.
But if the backdrop is better, the structural issues that have dogged Rolls for years remain and JP Morgan expects Erginbilgic’s results presentation to “be a hard-headed analysis of current strategy and financial position”.
“As we have previously argued, RR’s EBITA [underlying profit] is too low and the only way it is able to generate FCF [free cash flow] is by collecting customer advances on long-term service agreements,” the US bank stated earlier this month.
Rolls derives 80% of its civil aftermarket revenues from these long-term agreements, noted the broker, where airlines are charged on a price-per-engine flying hour for maintenance, which transfers risk to the engine manufacturer if maintenance costs are higher than expected.
Cash flow has for years been the Achille’s heel of Rolls-Royce, as JP Morgan’s unsparing assessment pointed out: “[Its] balance sheet is very weak with adjusted net debt of c£15bn in 2022E (including customer advances, pension liabilities, money owed to JVs, and cash provisions).
“The recovery in RR’s wide-body engine flying hours (EFH) is also materially lagging expectations.”
A recovery in air travel would presumably help address that, but JPM added that when Rolls-Royce announced its rights issue in October 2020 its “reasonable worst case” scenario was that 2022 flying hours would be 80% of 2019.
JPM said its forecasts for 2022 EFH will actually be 63% of 2019 and some short-term pain needs to be applied for a long time gain.
The US bank’s price target is 70p, which compared to today’s 112p, suggests a lot of unpleasant medicine is on the way.
Barclays is more upbeat with a price target of 110p and adds it likes the recovery story, but even it suggests after the recent run to wait until 23 February to see just what the new CEO has in store.
For Rolls investors, that looks like one date in the diary to circle.