The Rolls-Royce (LSE:RR.) share price is back on the move this morning as investors celebrate yet another set of record-breaking results. The engineering giant was largely thought to be on its last legs a few years ago. But after some radical changes to its corporate structure, the new CEO, Tufan Erginbilgic, seems to be propelling the business back to glory.
Over the last 12 months, the FTSE 100 stock has more than tripled! The group’s new strategy appears to have finally started sealing the cracks in the balance sheet as well as getting the bottom line back into the black. And following today’s (22 February) results, this trend seems to be here to stay, with the shares up 7% in early trade. Let’s take a closer look.
Record free cash flow
A big part of Erginbilgic’s turnaround strategy focused on introducing cost efficiencies throughout each division. And it seems these efforts have started bearing a lot of fruit. Underlying operating profit margins across the Defence, Power Systems, and Civil Aerospace segments have all jumped into double-digit territory. The latter, in particular, has enjoyed the biggest boost, from 2.5% a year ago to 11.6%.
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As such, Rolls-Royce’s overall underlying profitability reached 10.3% delivering £1.6bn of operating earnings. That’s significantly ahead of expectations of £1.2bn to £1.4bn. And it’s translated into free cash flow skyrocketing from £505m to £1.28bn – a 154% jump!
So, what’s driving these impressive results? The biggest catalyst is, unsurprisingly, the continued recovery of the commercial airline market. Large-engine flying hours have recovered to 88% of 2019 versus 65% a year ago. Meanwhile, several of the group’s prominent customers, such as Air India and Turkish Airlines, have been revamping their fleets. As such, orders for new large engines have reached a 15-year high for Rolls-Royce.
Pairing this with continued progress in the other divisions as well as lower cash costs, it’s no wonder that free cash flow is thriving.
What about the balance sheet?
Understandably one of the biggest concerns surrounding this business is the state of its financial health. After all, during the fallout of the 2020 pandemic, there were justified concerns that this business would collapse under all its debt.
Today, the firm still has just over £5.7bn of financial liabilities to contend with. That’s down slightly from the £5.9bn reported at the end of 2022. However, with the sharp increase in free cash flow generation, cash & equivalents on the balance sheet have jumped considerably. As such, Rolls-Royce’s net debt position tumbled from £3.25bn to £1.95bn.
Needless to say, that’s an encouraging sight. As is management’s guidance for even better profits and margins in 2024. However, there are still a few question marks. Dividends have yet to return to the fold. And with large-engine flying hours expected to make a full recovery in 2024, the recovery tailwinds may soon come to an end.
Therefore, growth may suffer a significant slowdown in 2025 and beyond. That could end up adversely impacting Rolls-Royce’s explosive share price performance to date. But overall, I’ve become increasingly optimistic about this business as a potential investment for my portfolio.
