Rolls-Royce is on a smoother flight path at last
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When a Rolls-Royce engine on a Cathay Pacific Airbus A350 caught fire shortly after taking off from Hong Kong last week, the aviation industry’s collective groan could be heard around the world. Shares in Rolls-Royce fell 6.5 per cent as investors worried that its recovery was in jeopardy.
Happily, it appears to have been a false alarm. The problem lay with an easily-replaced fuel pipe, rather than matching the scale of an earlier flaw on the Rolls-Royce Trent 1000 engine for the Boeing 787, which cost £2bn to remedy. That emerged in 2017 and the final part is only now being certified: in aerospace, fixing failures tends to take a long time and be very costly.
Rolls-Royce knows this better than most. There is no finer name in the industry, with an aircraft heritage reaching back to the Eagle engine designed by Henry Royce in 1914. But its recent history is distinctly patchy: it was nationalised in 1971 when it ran low on cash and has struggled to grow smoothly since being privatised in 1987. It has not been a Rolls-Royce operation.
Small wonder that Tufan Erginbilgiç, its no-nonsense chief executive, dubbed the company a “burning platform” when he arrived in January 2023. The Erginbilgiç strategy of culling managers and raising prices has worked: “A hundred times zero is still zero,” is his mantra when faced with internal calls to boost sales by signing low-margin contracts. The share price has more than quadrupled since he came.
It is a remarkable turnaround. Analysts who have for decades doubted Rolls-Royce’s ability to deliver on its promises have finally turned bullish. Erginbilgiç has briskly imposed private equity-style disciplines on a culture dominated by over-optimistic and financially wayward engineers, and has so far won. “He is a terrific operator, demanding and clear,” says one Rolls-Royce veteran.
Erginbilgiç also had impeccable timing. Not much happens quickly in the industry, and he actually inherited from his predecessor Warren East a platform that was poised for growth, having stopped burning after a critical period during the pandemic. Nick Cunningham, an analyst at Agency Partners, notes that Erginbilgiç is not only a skilled leader but a lucky general.
Two cycles have worked to his advantage. One is the fact that people are flying more. Engines are often sold to airlines on lease-like contracts under which manufacturers guarantee their reliability in return for cash payments based on flying hours. Rolls-Royce makes an initial loss on selling most commercial aircraft engines and the rewards grow as they are flown.
The second cycle is the maturity of its portfolio. It costs billions to design and develop a new engine and it is also expensive if one turns out to have a problem that needs a redesign (as with the Trent 1000). But after about a decade, a reliable engine becomes highly profitable. As in the music and book publishing industries, the most desirable asset is a solid backlist.
Erginbilgiç can still achieve more by carrying on squeezing and avoiding further nasty surprises. The company is only now generating sufficient cash to repair its battered balance sheet and consistency carries considerable rewards. As last week’s fright in Hong Kong showed, investors still do not rate Rolls-Royce as highly as rivals such as Safran and GE Aerospace: it hasn’t earned respect yet.
But the ultimate prize is to make it far bigger in civil aerospace, along with its defence and power systems divisions. It now has about a 50 per cent share of new engine orders for widebody aircraft such as the Airbus A350. Its challenge is the absence of Rolls-Royce engines on single-aisle jets such as the Airbus A320 and Boeing 737 Max — a larger and faster growing market.
Rolls-Royce left a single-aisle engine partnership with Pratt & Whitney in 2012 because of the financial demands. It may get another chance in the 2030s on the next generation of such aircraft and it is developing a new engine technology called UltraFan. But it will need greater scale to make and overhaul so many engines, although Erginbilgiç says it would seek a partner.
Turbulence does not only strike Rolls-Royce: Pratt & Whitney faces a $3bn problem with its own geared turbofan engines on Airbus aircraft. The question is whether Erginbilgiç can exploit its newfound stability not only to improve today’s business but to give it as great a future as its name.
He may no longer be in charge when that happens, given that he is 64. But at Rolls-Royce, a leader must both improve the platform and build another for their successor. That is now his job.