Rolls-Royce reported underlying revenues of £5.6 billion in the first half of the fiscal year, down 24% over the corresponding period last year. It reported an underlying operating loss of £1.7 billion. The results include a one-time charge of £1.2 billion in its Civil Aviation business that was necessitated due to the pandemic.

Rolls-Royce’s underlying net loss swelled to £3.3 billion on a non-cash loss in its forex hedge book.

Rolls-Royce decisive actions in response to COVID-19

• Significant H1 impact from COVID-19; timing and shape of industry recovery remains uncertain
• Successful execution of cost mitigations; £350m delivered in H1 towards £1bn 2020 target
• A fundamental restructuring of Civil Aerospace; > 4,000 group headcount reduction by 27 August
• Defence remained resilient; Power Systems experienced disruption in some end markets
• Rapid actions are taken to strengthen liquidity; £6.1bn at end H1 and £2.0bn loan agreed in H2
• Targeting potential disposals to raise at least £2bn, including ITP Aero and other assets
• Reflecting uncertainties, reviewing a range of options to further strengthen our balance sheet

Warren East, Rolls-Royce Chief Executive said:

“We ended 2019 with good operational and financial momentum. However, the COVID-19 pandemic has significantly affected our 2020 performance, with an unprecedented impact on the civil aviation sector with flights grounded across the world. We have responded rapidly to increase our liquidity, with £6.1bn at the end of H1 and a further £2.0bn term loan agreed in H2, to help weather the continued uncertainty around the timing and shape of the recovery in the civil aviation sector.

We have made significant progress with our restructuring, which includes the largest reorganisation of our Civil Aerospace business in our history. This restructuring has caused us to take difficult decisions resulting in an unfortunate but necessary reduction in roles. These actions will significantly reduce our cost base, which combined with a recovery in Power Systems and continued resilience in Defence, will help us to deliver significantly improved returns as the world recovers from the pandemic.

While our actions have helped to secure the Group’s immediate future, we recognise the material uncertainties resulting from COVID-19 and the need to rebuild our balance sheet for the longer term. We have identified a number of potential disposals that are expected to generate proceeds of more than £2bn, including ITP Aero and a number of other assets.

Furthermore, in light of ongoing uncertainty in the civil aviation sector, we are continuing to assess additional options to strengthen our balance sheet to enable us to emerge from the pandemic well placed to capitalise on the long-term opportunities in all our markets.”

First Half Group financial summary

• Underlying revenue of £5.6bn, down 24%, and reported revenue of £5.8bn, down 26%.
• Underlying operating loss of £(1.7)bn including one-off charges of £(1.2)bn in Civil Aerospace, largely related to COVID-19.
• Rolls-Royce reported operating loss of £(1.8)bn included £(1.1)bn impact from impairments and write-offs and £(366)m restructuring charges partly offset by a £498m exceptional credit on the Trent 1000 programme, driven by COVID-19.
• US$10.3bn reduction in FX hedge book to US$26.2bn to reflect lower forecast US$ receipts; resulting in a £1.46bn underlying financing charge.
• Rolls-Royce reported loss before tax of £(5.4)bn included £(2.6)bn non-cash loss from the revaluation of our FX hedge book; Underlying loss before tax of £(3.2)bn.
• Rolls-Royce reported post-tax loss of £(5.4)bn; Underlying post-tax loss of £(3.3)bn.
• Free cash outflow of £(2.8)bn; 47% lower large engine flying hours and significant working capital outflows including £1.1bn negative impact from our choice to cease invoice discounting.
• Liquidity of £6.1bn comprising £4.2bn of cash at 30 June, and £1.9bn undrawn revolving credit facility (RCF). Additional £2.0bn undrawn term loan announced in July and finalised in August.
• Net debt of £(1.7)bn excl. lease liabilities (FY 2019 net cash of £1.4bn).
• Free cash outflow of approximately £(1)bn expected in H2 reflecting an acceleration of cost mitigations, resulting in approximately £(4)bn FY 2020 outflow.

Impact of COVID-19 on Rolls-Royce H1 results

Although we started the year with positive momentum, the global COVID-19 pandemic severely impacted our H1 performance and medium-term forecasts. The most pronounced effect was seen in Civil Aerospace with large engine deliveries and flying hours both down around 50% in H1 including a 75% reduction in engine flying hours in Q2, however business jets and regional flying hours were more resilient.

In Power Systems, which was less severely impacted than Civil Aerospace, industrial markets were suppressed, economic disruption and lower utilisation impacted demand for services while government marine was stable. Defence remained resilient with no material impact on results from the pandemic and delivered strong profit growth. ITP Aero was impacted by the same adverse industry trends as Civil Aerospace.

Underlying results: The £(3.2)bn underlying loss before tax primarily reflected the impact of COVID-19 on Civil Aerospace with lower aftermarket profit, underutilisation of operations, lower spare engine sales as well as £1.2bn of COVID-19 related contract catch-ups and one-time charges resulting from a reduction in forecast flying hours, a reassessment of the timing and parking of aircraft and the viability of airlines.

Lower expected US$ receipts over the next seven years resulted in a £(1.46)bn underlying finance charge as we took the necessary decision to reduce the size of our hedge book by $10.3bn. In addition, we were net purchasers of US$ in H1 2020 and therefore unable to utilise our hedge book in the period.

This resulted in the translation of our H1 2020 results at an effective GBP: US$ rate of 1.24. This compared to an effective GBP: US$ rate of 1.53 in H1 2019, when we utilised our hedge book to sell excess US$.

Reported results: Our reported results were further impacted by £(1.1)bn impairment charges and write-offs, £(0.4)bn exceptional restructuring charges and adverse FX fluctuations leading to a £(2.6)bn negative movement on the mark-to-market of the hedge book, partly offset by £0.5bn improvements in the expected in-service costs of Trent 1000 durability issues, which were all a consequence of COVID-19.

In response to the sudden market deterioration, we executed a number of specific mitigations to reduce our cash expenditure with an expected cash flow benefit of at least £1bn in 2020, of which approximately £350m was achieved in H1. These mitigations include minimising discretionary expenditure such as non-critical capital expenditure projects, reducing consulting spend, professional fees and sub-contractor costs and reducing salary costs across our global workforce including a 20% reduction for senior managers and executives.

In addition, we launched a major restructuring of our Group, in particular our Civil Aerospace business, to remove at least 9,000 roles with forecast annualised pre-tax savings of over £1.3bn by the end of 2022. This, together with the expected recovery in engine flying hours, underpins our targeted recovery to positive free cash flow during H2 2021.

Throughout the pandemic, we have worked hard to safeguard our people while ensuring our operations have been able to continue. We have implemented measures to protect against the spread of the virus at our sites around the world and increased our focus on employee mental health and wellbeing. Furthermore, we have been providing practical assistance to aid the recovery for the countries and communities in which we operate. This included launching the Emergent Alliance, a global community with more than 140 members that is using data analytics to assist the global economic recovery.

The Board decided that given the uncertain macro outlook they would no longer be recommending a final shareholder payment of 7.1 pence per share in respect of 2019, resulting in cash savings equivalent to £137m. For the same reasons, the Board has not approved an interim shareholder payment for 2020.

Near-term liquidity position

Following rapid management actions to reduce costs and secure additional liquidity, we started the second half with the liquidity of £6.1bn (comprising £4.2bn cash at end H1 and a £1.9bn undrawn RCF) compared to £6.9bn at 31 December 2019. In addition, we now have a £2bn undrawn term loan, partly backed by the UK Export Finance (UKEF), announced in early July and finalised in August.

There is an inherent uncertainty over the severity, extent and duration of the disruption caused by the COVID-19 pandemic and therefore the timing of the recovery in our key markets, particularly in the civil aviation sector. In our base-case scenario (further details on page 24), where there is assumed to be no second wave and we see a gradual recovery with Civil Aerospace returning to around 70% of the 2019 level in 2021 we consider that we will continue to operate within our current available committed borrowing facilities for the next 18 months. In this scenario, in order to provide sufficient liquidity headroom, we would replace the £1.9bn RCF following its expiry in October 2021, with replacement funding of a similar amount.

Based on our base case scenario we expect the following significant cash movements over the next 18 months:

• Anticipated H2 2020 free cash outflow of approximately £(1)bn and £(400)m further cash costs related to the restructuring programme;
• Targeted return to positive free cash generation during H2 2021. However, for the full year 2021, we still anticipate a free cash outflow, albeit at a significantly reduced level year-on-year;
• Expected additional cash costs in 2021 outside of FCF, including restructuring costs as well as the final DPA payment of £(148)m due to be settled in January 2021; and
• Debt maturities of approximately £3.2bn will take place between now and the end of 2021 comprising: £1.9bn additional RCF (currently undrawn), £0.3bn COVID-19 Corporate Financing Facility (CCFF) commercial paper, and two bonds of $500m and €750m respectively.

In the event of a severe but plausible downside scenario (further details on page 25) the projections indicate that we will continue to operate within our available committed borrowing facilities for the next 12 months. When considering a period of 18 months from the date of this report, to 28 February 2022, we would need to draw down on the £1.9bn RCF, which is repayable in October 2021. In order to fund operations and maintain a sufficient level of liquidity, replacement of the £1.9bn would be required, along with additional funding which could be achieved through some combination of debt, equity and the proceeds from business disposals.

We continue to monitor the recovery closely and are assessing steps to further protect our financial position.

Strengthening our balance sheet

The impact of COVID-19 has resulted in a significant near-term deterioration in the Group’s net debt position. At 31 December 2019, the Group had a net cash position of £1.4bn, before lease liabilities of £(2.4)bn. This position benefited from £1.1bn of factored receivables that were outstanding at the end of 2019, a practice we ceased in the first half 2020. Net debt at the end of H1 2020 was £(1.7)bn, before lease liabilities of £(2.3)bn. Based on our market assumptions and despite the mitigating actions we are taking, we expect our net debt position to have significantly increased by the end of 2021.

A strong balance sheet is required for the markets in which we operate and strengthening our balance sheet remains our primary capital allocation priority. We view this as particularly important due to our long-term customer relationships and the cyclical nature of civil aviation. We remain committed to our ambition of an investment-grade credit profile in the medium-term and aim to return to a net cash position.

With this in mind, we are already pursuing several actions to strengthen our balance sheet. We are implementing a range of initiatives to return to positive free cash flow during H2 2021, and to then deliver strong and sustained cash flow from FY2022 onwards.  In addition, we are reviewing our portfolio to identify assets that are no longer key to our future strategy to raise proceeds of at least £2bn within the next 18 months.

We have identified various assets for potential disposal, including ITP Aero, and the appropriate preparation work is underway. We will also explore options to increase the scope of ITP Aero’s supply chain and manufacturing activities. Notwithstanding the outcome, ITP Aero is a key partner and we will retain a long-term relationship with the business across our Civil Aerospace and Defence programmes.

We will pursue any disposals under a timeline and structure that maximises value for our shareholders.  Any potential disposals are also, of course, dependent on market conditions.

In addition, we continue to review a range of funding options to further strengthen our balance sheet.

Positioned for improved financial performance

Our extensive self-help actions will enable us to emerge from the pandemic with a significantly changed Civil Aerospace business, which will have around a third smaller headcount compared with 2019 and leaner, less capital-intensive operations alongside a facility footprint that is concentrated on fewer sites globally.

Furthermore, we are looking at new forms of industrial collaboration to deliver more compelling returns for shareholders. For example, we are actively exploring potential new forms of industrial partnership in relation to the UltraFan programme. This, taken together with the aftermarket returns generated by our young and extensive installed base of more than 5,000 large engines, positions us well to deliver significantly improved returns as the market recovers.

We have a resilient Defence business currently engaged in a number of new contract opportunities, which, if successful, will drive significant future long-term growth. Power Systems is well-positioned to benefit from the recovery and from continued demand for mission-critical power. In H1 2020 we continued to pursue geographic opportunities and disciplined investment in expanding our product portfolio of sustainable technologies, whilst working actively to deliver cost efficiencies from our manufacturing cost base and footprint.

Our leaner Civil Aerospace business combined with the growth opportunities in Defence and Power Systems position us well to deliver significantly improved returns and gives us confidence in the fundamentals of our long-term future.

Outlook for Rolls-Royce

Uncertainty remains high as a result of COVID-19, particularly around the easing of travel restrictions and the pace of economic recovery. Our recovery assumptions are based on a gradual recovery in civil aviation activity commencing towards the end of H2 2020. Most Power Systems end markets are currently expected to recover by the end of 2021 and revenues are expected to be back to 2019 levels in 2022. Defence performance is expected to remain resilient throughout the period.

Since the low point in April when large engine flying hours were down 80%, Rolls-Royce has seen a modest recovery to between 70% and 75% down in May, June and July.  An overview of our base case expectations for the key Civil Aerospace metrics is detailed below while recognising there is material uncertainty around the future timing and shape of the recovery. In reaching these expectations we have considered current airframer build rates, industry and macroeconomic forecasts, together with bottom-up analysis of our fleet.

Beyond 2022, Rolls-Royce expects large engine deliveries to gradually increase, albeit remaining below 2019 levels until the middle of the decade.