Rolls-Royce Profits Hit by Foreign-Exchange Charge; Guidance Maintained

Narrow-moat Rolls-Royce reported a very pedestrian set of first-half results. Its operating profit in the first half of GBP 125 million is less than half of last year’s level largely due to a foreign-exchange charge of GBP 270 million and lower profits in the defense business. The power systems business was the only bright spark in the portfolio with tripled EBIT due to strong sales growth and operating leverage. Cash flows improved by GBP 1.1 billion, just below neutral. Full-year guidance for slight revenue growth, flat margins, and modest free cash flow was maintained. Rolls-Royce is trying to sell the long-term story of growth in its new markets segment, which includes electric planes and small modular nuclear reactors. Although we believe Rolls-Royce has the capabilities to invest in these growing markets, they are far from being commercially viable and the medium-term prospects of the group will rest on the performance and recovery of the civil aerospace segment.