By Max Clarke
“Rolls-Royce has delivered a strong performance in 2010 with record underlying revenues and profits. This reflects our global customer base and the balanced portfolio of products and services that we offer. It is a measure of progress that the Civil, Defence and Marine businesses now each generate underlying profits of more than three hundred million pounds. During 2011 the Group expects good profit growth and a modest cash inflow, said Rolls Royce Chief Executive Sir John Rose.
“John Rishton will take over from me as Chief Executive. I wish him and all the team at Rolls-Royce continued success.”
Rolls-Royce performed well in 2010. The order book grew in the period to a record £59.2bn. Underlying revenues rose to £10.9bn, underlying profit increased to £955m and average net cash to £960m. This robust performance was achieved despite significant challenges.
These results demonstrate the Group’s resilience. The breadth and balance of our portfolio and the Group’s strong position in global markets have made the business more flexible and better able to deal with economic shocks and unexpected events. This has allowed Rolls-Royce to maintain progress throughout the global financial crisis and subsequent disruption to the world economy which began in 2007. During this three year period the business has grown underlying revenues by 39%, profits by 19% and average net cash by £610m whilst increasing payments to shareholders by 23%.
We have continued to invest for the long-term, spending more than £4bn since 2007 in facilities, plant, IT, training and product development. These investments are funding world class facilities in all major geographies, providing capacity for future growth, contributing to improved productivity and delivering products with operational lives most of which are expected to extend to thirty years and more.
Recovery in the global economy remains uneven, with growth subdued in a number of developed countries. This makes it particularly important that Rolls-Royce has the ability to access those markets where demand remains strong for the complex integrated power systems and services that we supply and which others cannot easily replicate because of high barriers to entry.
During 2010 the Group has made good progress with a number of the key development programmes which underpin our future growth. These include the Trent 1000 for the Boeing 787, the Airbus A400M, where the TP400 engine has now accumulated more than three thousand hours of flying time, and the Gulfstream G650, on which the BR725 successfully met all project milestones during the year. The engine for the Airbus A350 XWB, which is due to enter service in 2013, ran for the first time in June.
The submarine HMS Astute was accepted into service by the Royal Navy, with a second submarine, HMS Ambush launched recently. The Type 45 destroyer, HMS Daring successfully completed its programme of sea trials during the year.
The first Rolls-Royce powered Littoral Combat Ship (LCS) entered active duty with the US Navy, with a second vessel launched in December. Importantly, in January 2011, the US Navy confirmed an order for propulsion systems for a further ten Rolls-Royce powered Littoral Combat Ships, representing the most valuable naval surface ship order the Group has received.
In April, the Marine business completed the acquisition of ODIM ASA (ODIM), acquiring the remaining 67 per cent of shares for a cost of £147m, bringing the total cash investment in ODIM to £218m. ODIM adds capability to our strong marine systems portfolio in target markets such as seismic towing, oceanographic survey and subsea and deep-water installation systems.
An uncontained disc release occurred on a Trent 900 engine on board a Qantas operated Airbus A380 in November 2010. This regrettable incident attracted widespread attention. Uncontained disc failures happen with a frequency of about once a year on the world’s large civil aircraft fleet. However this was the first time an event of this nature had occurred on a large civil Rolls-Royce engine since 1994.
The safety of our products is our highest priority, and each time a serious incident happens, Rolls-Royce and the aviation industry learn lessons. These are embedded in the rigorous certification requirements, safety procedures and standards of regulation which make flying an extraordinarily safe form of transport. In line with this regime, Rolls-Royce worked closely with the regulators, Airbus and our customers to put in place an effective inspection programme, to identify root cause and to achieve a rapid return of the Trent 900 fleet to normal operation.
The bulk of the anticipated costs associated with this event have been recognised in the 2010 results. This is in line with the Interim Management Statement of November 2010.
A consistent strategy for long-term growth:
We are building our business through the disciplined application of our long-term strategy. This has afforded Rolls-Royce strong positions in four growth sectors: civil aerospace, defence aerospace, marine and energy. As an example, our success in the wide-body aircraft market means Rolls-Royce expects to more than double the number of Trent engines being delivered by the middle of this decade. This step change in volume, together with growth from the portfolio, requires consistent investment in new facilities and capabilities.
In 2010, good progress was made in the construction of major new facilities at Crosspointe in Virginia, USA, which has already started to manufacture components, and at Seletar in Singapore where we will assemble and test large civil engines such as the Trent 900, the Trent 1000 and the Trent XWB. These two state of the art facilities, covering approximately 87,000 square metres, or around four per cent of our current global footprint, will employ at least 850 men and women. Both are making good progress, with full operation at Crosspointe expected later this year and the start of operations at Seletar in 2012.
Rolls-Royce opened a Mechanical Test and Operations Centre at Dahlewitz in Germany, and a new facility to support the Lockheed Martin Lightning II Joint Strike Fighter (JSF) LiftFan capability in Indianapolis, USA. Rolls-Royce also expanded the Civil aerospace joint venture repair and overhaul facility in Singapore, increasing capacity to 250 large engines per year. In addition we opened a new joint venture icing test facility in Manitoba Canada.
We continue to develop our UK footprint with good progress on a new nuclear manufacturing facility for both naval and civil nuclear capability. In addition, we are supporting the development of six advanced manufacturing research centres, four of which will be based in the UK, to improve manufacturing performance across the supply chain.
We continue to expand our activities in civil nuclear power generation. Our capabilities in nuclear technology, developed over 50 years, position us well in this fast growing sector. During 2010 we secured contracts to provide nuclear instrumentation and control safety systems in Slovakia and in China. We have also deepened our understanding and relationships with reactor vendors and utilities in the UK and around the world.
Our consistent strategy has created a portfolio which we believe will double revenues in the next decade through organic growth alone. Our confidence in the long-term growth prospects of the Group is reflected in the decision to recommend a final payment to shareholders of 9.60 pence per share — bringing the full year payment to 16.00 pence per share, an increase of 6.7 per cent for 2010.
Strong financial position:
The Group’s financial position was further strengthened in 2010. Average net cash balances for the year were £960m, an improvement of £325m over the same period in 2009, with period-end cash balances improving £258m to more than £1.5bn. The Group’s debt maturities are well spread, with the debt credit ratings assessed by all major rating agencies as strong with a stable outlook. Following the maturity of the €750m Eurobond in the first half of 2011, the Group’s funding costs are expected to be reduced in 2011 by around £10m compared with 2010.
There have been no major changes in the position of the Group’s UK pension funds over the year. Two smaller UK funds completed their triennial actuarial valuations, with no significant changes in the Group’s net deficit position or ongoing cash funding requirements.
The availability of finance for our customers in the wholesale markets has improved over the course of 2010. As a result, the level of financial or contingent support remains modest.
Good access to global markets and a broad range of product and service offerings helped secure orders worth £12.3bn in 2010, ensuring that the Group’s order book increased to a record £59.2bn at the period end. Approximately £18.1bn of the order book relates to long-term service contracts. There were significant wins in all divisions. Civil Aerospace secured orders for more than 300 Trent engines. More than £2.1bn of new activity in Defence included substantial services contract awards to support US, Canadian and UK transport and combat fleets. In the Marine business there are encouraging signs of increasing demand in the offshore and commercial marine markets, and in 2010, the first order for the new Wave-Piercing design was signed. The Energy division continued to make good progress with overall orders in the oil and gas and power generation sectors similar to 2009; within civil nuclear there was healthy demand for instrumentation and control equipment and services.
Group revenues increased by six per cent to £11.1bn. Underlying revenues improved by seven per cent. There was good growth in underlying service revenues which increased by 13 per cent with double digit growth coming from the Civil Aerospace, Marine and Energy businesses.
The Group maintained its policy of managing foreign exchange risk through its long-term hedging programme in the period. The hedge book increased to $21bn at 31 December 2010 at an average rate of $1.60. Underlying profits in the period benefited by £74m. This included £72m from a nine cent improvement in the USD achieved rate, principally through the utilisation of the hedge book, and a further net £2m from translation benefits on overseas businesses, mainly NOK and USD effects. For 2011, USD achieved rates are expected to improve again by between six and nine cents contributing a further £50m to £75m to underlying profit.
Investment in research and development was £923m (2009 £864m), of which the Group funded £506m, approximately 4.7 per cent of underlying revenues. The charge to the income statement increased by £43m to £422m. This is a function of higher cash spend and slightly lower net capitalisation in the period. These trends are expected to continue in 2011 as more engineering resource is devoted to early-phase programmes, such as the Trent XWB where spend is charged to the income statement in the period in which it is incurred. As a result, the charge for research and development in the 2011 income statement is expected to be around £40m higher than in 2010.
The Group’s underlying trading result included a number of one-off items including the benefits from a spares distribution and logistics deal with Aviall. These substantially mitigated charges relating to the Trent 900 failure in November 2010 and a provision for retrofit charges in the Energy business.
Underlying profit before tax, which excludes the non-cash impact of the hedge book and other financial instruments, increased by four per cent to £955m (2009 £915m).
This profit growth reflected improved revenue mix from services in the period, good cost control, positive FX impact and broadly similar unit costs in the gas turbine activities partly offset by the ongoing headwinds associated with bringing new products to market, higher charges for research and development as well as the one-off items noted above. Despite these challenges, the Group delivered strong trading performances in Defence and Marine where profit grew by more than 20 per cent in each, and in Energy which grew by 13 per cent. This more than offset the reduction in profitability in the Civil business.
The Group’s reported profit before tax was £702m, compared with £2,957m in 2009, and included the effects of the “mark-to-market” of its financial instruments, for which hedge accounting is not adopted. The impact of mark-to-market is included within net financing in the income statement (see note 3 on page 29).
The underlying tax charge of £236m increased £49m from 2009 as the effective rate rose to 24.7 per cent for the period, from 20.4 per cent in 2009. The 2009 effective rate benefited from a one-off £35m credit following the successful completion of overseas tax audits and changes in legislation. The underlying tax rate is expected to remain at around 25 per cent in 2011.
Underlying earnings per share declined by two per cent to 38.73p (2009 39.67p), primarily reflecting a higher effective tax rate in 2010. Basic earnings per share were 29.20p (2009 120.38p), reflecting the mark-to-market adjustments described above.
The Group reported a good cash performance. Net cash inflow was £258m for the period, reflecting an increase in underlying profitability, improved working capital performance and the receipts of inventory disposals under the Aviall distribution services agreement. Significant outflows during the year included the acquisition of ODIM ASA, increased investments in product development and facilities and higher payments for taxes and to shareholders in the period.
Our consistent strategy has created a broad and balanced portfolio, and established a strong financial foundation from which to support investment in technology, capability and capacity.
We continue to experience strong demand in emerging economies, which is more than mitigating a subdued recovery in some of our traditional markets. The strong order book and balanced portfolio gives us confidence that the Group will double revenues organically over the next decade. We continue to have the management and financial capacity to accelerate growth through acquisition and partnership.
The Group expects underlying revenues to grow modestly in 2011. We anticipate a slowdown in original equipment revenues in the Marine business and to experience the initial impacts of spending cuts by some customers in our Defence business. However, this is expected to be more than compensated for by growth in service activities in the Civil aerospace and Marine businesses.
Group underlying profits in 2011 are expected to see good growth benefiting from a strong trading performance in the Civil aerospace business, a better revenue mix, improved achieved foreign exchange rates and a continued focus on cost control. The Marine and Defence aerospace businesses are expected to deliver stable performances despite the current challenges in their markets and the Energy business is expected to deliver good profit growth in the year.