Earnings Call: H1 2015

Jul 30, 2015

Slides

Hello and welcome to this Rolls Royce Holdings PLC twenty fifteen Half Year Results Fixed Income Conference Call. Throughout this call, all participants will be in listen only mode. Afterwards, there will be a question and answer session. And just to remind you, this session is being recorded. I'll now hand you over to the Group Chief Financial Officer, David Smith. Please begin. Good afternoon or good morning. Let me just give you a summary of some of the key highlights I think of our presentation this morning. We did have a more difficult first half. It was a slower start I think as we'd indicated earlier in the year. And that effectively reflected the phasing that we will see this year on engine deliveries, product mix and also R and D spending. The good news was our order book was up and actually at record levels in both our Civil and Power Systems businesses at €76,500,000,000 So that's a really good positive for the long term. Just in terms of some of the specifics, revenue at 6,250,000,000.00 was down about 3% from last year, although that was mainly FX related. Profit was down more. It was down about 30%. And I'm going to come back in a second to some of the main drivers of that. And our free cash flow of $576,000,000 although actually better than we'd originally anticipated, clearly was a drop versus what we delivered in the same period last year. We're still expecting to deliver a breakeven or better result for the year on cash flow, so to recover that drop that we saw in the first half. And then finally, we did increase our dividend by 3% in line with our progressive dividend policy. So let me just go through some of those numbers in a little bit more detail now. Starting with our revenue. So as I said, our revenue at $6,250,000,000 was down versus last year, but actually flat once we adjust for the effects of the stronger pound on translating foreign currencies back into sterling. Within that, we saw growth in Aero Services. Actually it's quite good growth at about 7%, but we saw a lower volume in our Land and particularly around OE project product in both Power Systems and Marine. Our profit, as I said, at $439,000,000 on an underlying basis for the year was down about 30% from last year or €218,000,000 after adjusting for exchange. The biggest driver of that was trading margin. And within trading margin, we saw significant volume effects, particularly engine mix in our Civil business, volume and mix in our Marine business and also the fact that we took a $30,000,000 onetime charge for a contract we don't expect to complete now in Marine and then adverse volume and particularly adverse mix in our Power Systems business. The other main factor that drove the reduction in profit year over year was higher net R and D charge to profits, which was a combination of higher spend and also a lower level of capitalization. So we expensed as opposed to capitalized more on R and D during the period. And that just really reflected the timing of where various programs are in their capitalization profile. Let's turn now to cash very quickly. So the $439,000,000 of profit as I said became minus €576,000,000 on free cash flow. The biggest driver of that was working capital and primarily trade working capital, which was €747,000,000 negative. And that included around €400,000,000 on net receivables payables. We had a stronger close to the year last year and that increased the level of payments out to suppliers in the first part of the half. And then equally with quite a few deliveries right at the tail end of the half that built up our receivables and that cash will come in, in the second half of the year. Driver was inventory. Part of that was planned in terms of preparation for higher deliveries next in the second half of the year. Part of it was unplanned, which was a combination of some supply shortages in a couple of our business units, but also the market conditions in Marine leaving us with more inventory. And we plan to reverse that inventory build in the second half of the year, if not do a little bit better than that. And that's part of our plan, as I said to get back to a breakeven cash flow for the full year. Our financial strength is really important to us and we are very focused on maintaining investment grade rating. One of the things that we did during the first half was to refinance, as many of you know, our revolving credit facility and we increased that overall to $1,500,000,000 And we also took the decision, which we announced back on July 6, to curtail our share buyback at $500,000,000 rather than continuing for the $4,000,000,000 that we previously announced. This in my view was a prudent decision. I'm confident that cash flows will improve significantly over time, but I want to make sure that we maintain the right level of liquidity in the business during the short term, especially as we will be facing some additional headwinds over the next two or three years, which I'm going to come back to in a second. Just talking about some of the individual businesses. Our Civil Aerospace business, as I said, had a record order book, which was strongly positive. We also saw good growth in our Services business particularly, but we were impacted by quite a change in mix between more profitable linked deliveries on the Trent seven hundred and nine hundred, which were replaced by Trent 1,000 and XWB, which were unlinked and therefore on which we do not book in advance aftermarket profit. In addition to that mix change, we also saw some weakness in business jets and also in the regional aftermarket and our smaller jet businesses as well. But as I said, our overall aftermarket revenue was actually quite a strong positive for the first half and we expect that to continue into the second half. Overall civil profit therefore declined by about 40% against a revenue picture, which was up a little bit. And that's something that clearly was impacted very much by these mix changes. And also some other factors as well the higher R and D that I mentioned earlier and lower utilization of some of our lease engines. In the second half, we are expecting to book some further improvements in our long term contract profitability, including releasing a provision that we've had or that we've been building since launch on Trent 1,000 launch engines and that's going to be based on improved operating performance. And we'll test that technically during the second half before we release that provision. Defense Aerospace had a relatively quiet, but a slightly overall positive quarter. We saw a little bit of volume drop, but that was primarily due to some supply shortages that will recover in the second half of the year. And we've got very good order cover in the second half of the year. So we're confident that we'll be able to deliver defense at pretty much the same sort of result as we saw last year overall for the year. Turning now to our Land and Sea businesses very quickly. Power Systems, we did have a slow start for the year. That actually improved quite significantly as we went through the first half and we had a very strong May and actually a record June. Now clearly for the two months I can't say make or summer, but it's absolutely true I think that Power Systems now has some momentum. And their order book actually increased by 12% during the quarter up to $2,200,000,000 So that's a record level for them. And I think we've got quite good confidence now based on those plans and the order book coverage to deliver a much stronger result in the second half of the year. So that weakness in the first half did affect profitability as well and it was aggravated by the fact that within the lower volume we also saw an adverse mix. Some of that is going to be reversing again in the second half of the year. Marine was as all of you I'm sure was still heavily affected by the difficult conditions in the offshore market driven by the significant fall in the oil prices over the last year. And that caused both a very weak order intake. Order intake was down 46% and therefore our order book declined. But also increasingly we're seeing deferrals of orders and therefore had an impact on revenue and weakness in the aftermarket. So profit fell sharply in Marine. In addition to the trading related reductions, we also as I mentioned a few minutes ago took a $30,000,000 charge related to a contract that we don't believe we'll now complete. And in addition during the quarter, we did announce 600 redundancies during the first half sorry. And we will probably make some further announcements on redundancies in the second half of the year although that's contained within the guidance that we've given. Nuclear, our Nuclear business is now separated out from Energy. That happened last year. And we had sort of quiet again, but relatively positive quarter with both revenue and profit up. And I think they will also have a solid year this year. So that really completes the overall picture. Our guidance for the year remains unchanged with the revised guidance that we gave on July 6. And that's true at a segment level as well. The only segment level guidance that we have changed was for Marine reflecting the trading conditions as I discussed previously. So it is going to be a challenging second half, but there are a number of factors I think that are very positive and will drive this. Firstly, continued service growth in civil building on that 7% growth in the first half of the year. We do expect higher engine deliveries partly from recovery of some of these supply shortages, but also the ramp up that's already planned in the second half of the year in the Civil business. We will have a somewhat lower R and D charge. And as I said, some significant impacts on profit from reversal of provisions that we've taken previously on the Trent 1,000 engine and also improvements in total care costs as well. In Land and Sea, a much stronger second half for Power Systems as I described. I think we have the momentum to deliver that now and we've rebased the marine forecast to give I think a very realistic picture for the balance of the year. So that's 2015. We did also recap what we talked about on July 6 in terms of some of the headwinds that are facing us over the next two or three years, particularly the transition from the Trent 700 to the Trent 7,000 engine as Airbus run out the A330 in its current form and introduce the A330neo from 2017 onwards. This is going to be a very difficult transition as Airbus announced a big reduction, 40% reduction in February in volume. But this isn't just about volume. These are very tough commercial sales and both ourselves and Airbus I think are finding that very difficult. And we're also still in competition ourselves on the actual engine selection. So we are expecting in addition to the volume drop significantly weaker pricing on both the OE and the aftermarket on these sales as well as a lower demand for spare engines. And as we said to the market a couple of weeks ago, we think that's about a $250,000,000 overall for the Civil business in 2016 and indeed in 2017. Incremental to that, the weakness in business jets and regional aftermarket will increase that number to about $300,000,000 for civil. And we will continue to see, we believe, certainly through 2016, a fairly weak picture in the offshore market as well. So it was important that we reiterated that. The impacts on cash won't be as severe because a lot of this is related to the nature of the linked accounting for the Trent seven hundred, but still there will be some impacts on cash. But overall, we should see cash conversion improve. I finished my presentation and really Warren built on this by talking about some of the long term trends, because I think it's very important I think when looking at these period results to keep in perspective really that this business is on a multiyear journey to actually transform itself both in terms of its product portfolio and its industrial base. We have a $76,000,000,000 order book. That's a record order book. We have a lot of very good long term trends that will continue to drive both sides of the business. And the embedded value as our civil large engine market share on an installed base moves up towards 50% is very significant in terms of the aftermarket revenues and cash and profits that that will generate. We're continuing to invest in technology and in this major industrial transformation that I've described right across the business. Just to put this market share issue on widebody in perspective, it's taken us thirty years to get to this position and we're within five years really of achieving it now. And that is supported by our order book, which will deliver this. And as I said, once we get to this kind of level of installed base market share and wide bodies, we'll be in a very strong position to continue to drive profitability in the aftermarket, which is one of Rolls Royce's absolute key areas of expertise. In addition, I think the Trent XWB is an extremely important project for us. We are just really beginning the deliveries on that program. It will be generating cash through the next forty or fifty years. And when we think about that, the cumulative cash flow that we expect from that program is actually twice as great as the best ever program in Rolls Royce's history, which is a Trent 700. And in fact, as we get into the next decade, we'll have both the Trent 700 continuing to be a strong cash driver on the aftermarket, but the XWB as well. So hopefully that's an overall summary of what we discussed this morning. We also discussed a little bit about land and sea, but I probably covered And I'm sure you'd like a bit of time to ask some Q and A as well. Thank you. Ladies and gentlemen, we'll now begin our question and answer And as we have no questions on the telephone lines, I'll return the call to David Smith for closing comments. Okay. Well, thank you very much for your attention today. I see that there aren't any questions. So hopefully that means that we did a reasonable job of going through that information. It is very important that we commit keep a strong level of communication with this group. And therefore, I really value these calls. Hopefully that we can talk in the future. Thank you very much. This now concludes our call. Thank you for attending. Participants, you may disconnect your lines.