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Rolls-Royce swings to annual profit as restructuring pays off

Rolls-Royce expects 2018 results will be affected by costs related to repairs on some aero-engines
Shares in Rolls-Royce soared in early deals

Rolls-Royce Holdings (LON:RR.) swung to an annual profit as it cut costs as part of a restructuring to turn around the business.  

The company reported pre-tax profit of £4.9bn for the year to 31 December 2017, compared to a record loss of £4.6bn a year earlier. 

Shares jumped 11% to 923p in morning trade. 

The 2016 loss reflected a £651mln settlement with US and UK authorities over corruption charges and the impact of a weaker pound on certain contracts.

READ: Rolls-Royce see shares slump after record loss, but has corner been turned?

Excluding items, underlying profit increased to £1.1bn last year from £813mln in 2016.

Revenue rose to £16.4bn from £14.9bn, boosted by the delivery of more aero-engines and from its power systems unit that makes large diesel engines.

UBS repeated a ‘buy’ rating and target price of 1,000p on the stock, saying revenues and profits beat expectations.

Chief executive Warren East said the company was making good process in its restructuring and is on track to meet its target of generating free cash flow of £1bn by 2020.  

2018 results to be hit by engine repair costs

However, the group warned that 2018 results would be affected by costs related to carrying out repairs on some aero-engines.  

Rolls said it would take a £40mln hit to repair existing engines, mainly the Trent 1000 engine, which is installed on the Boeing 787 aircraft.

Between 400 and 500 Trent 1000 engines need maintenance due to problems with components wearing out earlier than expected. British Airways, Virgin Atlantic and Air New Zealand were among those affected.

Cash costs incurred last year for in-service engine issues on the Trent 1000 came to £119mln.

Rolls estimates 2018 group underlying operating profit of between £400mln and £100mln, compared to £321mln last year. It predicts “mid single-digit growth” in group revenues. Free cash flow is forecast at £350mln to £550mln after rising to £273mln in 2017 from £100mln a year earlier.

The guidance uses the new accounting standard IFRS, which changes the way the earnings are booked on long-term contracts.

Simplifying the business 

Under East's restructuring plans, the number of divisions will be cut from five to three core units of aerospace, defence and power systems. The company is also considering selling its commercial marine business, which has been hit by weak demand in offshore oil and gas markets since 2015.

"As I look to the year ahead, we are embarking on a more fundamental restructuring programme with a refreshed leadership team and an improved market environment,” said East.

"The new business structure provides us with a clearer focus on our customers and markets and, combined with our growing installed base, particularly of widebody engines, delivers the potential to drive sustainable long term free cash flow towards our mid-term ambition of around £1bn by around 2020 with further growth over the sUBSequent years."

The full-year dividend was maintained at 12p.

CEO's work not over yet, says analyst

AJ Bell investment director, Russ Mould, said East appears to be gaining traction with his turnaround plan as underlying pre-tax profit grew for the first time since 2015.

“An expanded restructuring programme shows his work is not yet done and the company also has to fork out cash to deal with durability issues on its Trent 1000 and Trent 900 engines," he added.

“Today marks an important milestone in the company’s recovery although there is still the risk of further turbulence.”

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