Patience and prudence have transformed an icon of the FTSE 100
Rolls-Royce’s profits soared in the first six months of this year. Britain’s flagship engineering company plans to restore its dividend for the first time since the pandemic.
So what? It’s a stunning turnaround for a company that was forced to raise £2 billion from shareholders to stay afloat in 2020. So what happened?
Rolls-Royce’s return to profitability – which has driven its share price to an all-time high – is a story of dogged persistence masked by eye-catching rhetoric from the boss.
Tough talk. It comes under the leadership of Tufan Erginbilgic, a former BP executive who told staff when he took over last year that the business was a “burning platform”, implying a leap into the unknown was needed to survive. His bluntness hasn’t just been directed at his workers. He has renegotiated loss-making contracts with plane manufacturers and airlines and successfully pursued a £100 million debt from a customer that had been written off.
Cutting costs. Rolls-Royce is shedding up to 2,500 jobs, around 6 per cent of its workforce. The streamlining brings together back-office operations like human resources that are copied across the company’s three divisions, from civil aerospace (the biggest) to defence and power generation.
Centralising. Erginbilgic created a new post of director of engineering, technology and safety, heading up a unit that can deploy engineering teams to the company’s highest priorities. The goal of this change is to make the business more flexible.
Yet the shift has been more gradual than Erginbilgic’s language and the company’s equally high-flown share price suggests. The cuts to headcount match those made by the previous chief executive, Warren East, who led the company through the pandemic. East shared the new CEO’s concern that the company was inefficient and tried to slim down its bureaucracy.
Economic tailwinds have also been blowing in Rolls-Royce’s favour.
- First, a return to flying after the pandemic – in civil aerospace, “large engine flying hours” were back at 2019 levels in the first quarter of this year, the most critical measure of all for a company that makes most of its money from servicing engines and needs planes to be in the air.
- Second, the strength of the US currency has helped a business that earns much of its revenue in dollars.
A weaker dollar – a potential consequence if there is a US central bank rate cut next month – will dampen Rolls-Royce’s prospects, though lower rates also make it easier to finance debts.
Less flight? The end of the post-pandemic air travel boom is a bigger risk. Airlines including Lufthansa warned this summer that while demand remains strong, there is intensifying pressure from passengers to keep fares down, squeezing profitability.
Erginbilgic’s “burning platform” speech suggested a company in dire trouble. That usually leads to one of two outcomes:
- A deep cultural overhaul, as with BP following the Deepwater Horizon spill in the Gulf of Mexico, when the oil giant had prioritised cutting costs over risks to safety. Bob Dudley rescued the company, creating a new safety unit run by Mark Bly, who had led BP’s internal investigation into the spill. (Erginbilgic, a former chief of staff to BP CEO Tony Hayward, will recall this era vividly).
Or…
- A strategic transformation. The last chief executive to describe his business as a “burning platform” was Stephen Elop, who ran Nokia from 2010 to 2014. The company went from being the world’s biggest mobile phone maker to an also-ran. Under Elop, Nokia cut tens of thousands of jobs and sold its phone business to Microsoft, but he failed to stem the collapse of its share price.
Neither of the two appears to be happening at Rolls, whose culture shift builds on changes that began in the pandemic. The single biggest potential change to its product offer is using its engines to power single-aisle planes that usually fly shorter routes. If that happens, it would mark a return to a business line the company exited more than a decade ago.
Rolls-Royce’s share rally has been a welcome reward for investors who were patient through the pandemic, but as a turnaround it’s been more subtle – and longer in the making – than its CEO’s tough talk suggests.
