Rolls-Royce: Turbines and Tribulations - [Business Breakdowns, EP.174]

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Jul 17, 2024

Graeme Forster from Orbis Investments shares his insights on Rolls-Royce's journey in the aerospace market. He discusses the company's historical evolution from luxury cars to aerospace dominance, highlighting engineering innovations and market dynamics. Graeme offers candid commentary on profit dynamics in civil aerospace and defense, emphasizing aftermarket strategy and operational efficiency. He also navigates the complexities of capital allocation and investment challenges during the company’s recovery, revealing how crises can uncover new opportunities.

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ANECDOTE

Rolls-Royce Origins and Aerospace Entry

Rolls-Royce was founded in 1906 by Henry Royce, an obsessive engineer, and Charles Rolls, a wealthy entrepreneur.
World War I pushed Royce into aerospace, leading to innovations like the jet engine but also financial struggles like the RB211.

INSIGHT

Rolls-Royce's Engine Sales and LTSAs

Rolls-Royce sells engines at low margins to airframers like Airbus, securing long-term service agreements (LTSAs) with airlines.
LTSAs, based on flight hours, generate most of Rolls-Royce's profit.

INSIGHT

LTSAs and the Insurance Analogy

Rolls-Royce's LTSA model, similar to insurance, should be very profitable due to its risk transfer and direct customer relationship.
Historically, they haven't fully captured this value, unlike GE.

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Today, we are breaking down Rolls-Royce. A fair warning to those expecting to hear about luxury automobiles, that division was split from this business in the 1970s. But as we discuss the history of Rolls-Royce on this episode, you will hear how the DNA of this company still ties together from its early 1900s origins.

Our guest is Graeme Forster from Orbis Investments. Graeme walks us through the core business of Rolls-Royce in the aerospace market, the evolving duopoly of the wide-body aircraft engine manufacturers, and the ups and downs of properly capturing the economic opportunity. I really appreciated Graeme's intellectual honesty in discussing Rolls, and I expect you will, too. Please enjoy this Breakdown on Rolls-Royce

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Show Notes

(00:00:00) Welcome to Business Breakdowns

(00:04:54) Overview of Rolls-Royce

(00:08:35) History and Evolution of Rolls-Royce

(00:10:44) Rolls Royce's Aerospace and Defense Ventures

(00:11:57) Challenges and Nationalization

(00:14:43) Current Business Segments and Market Position

(00:20:57) Service Agreements and Profitability

(00:27:41) Engineering Excellence vs. Commercial Strategy

(00:31:26) The Aerospace Business Ecosystem

(00:33:11) Rolls-Royce's Margin Profile

(00:35:13) Challenges and Changes in Management

(00:37:28) Cost Structure and Revenue Optimization

(00:38:32) Engine Performance and Development

(00:40:04) Market Dynamics and Competition

(00:49:13) Future of Nuclear Reactors

(00:52:46) Capital Allocation and Management

(00:56:08) Lessons from breaking down Rolls-Royce