Rolls flying high after results milestone

While the Rolls-Royce recovery still has some way to go, today's annual results from the engines giant did at least banish a few painful memories for shareholders following previous results disappointments.

And in producing figures at the top end of expectations, the FTSE 100 stock has shown why many analysts now think there's potential for Rolls shares to be trading at £10 and beyond. Rolls was at a four-month high today, having jumped 12% in the wake of the 25% rise in annual underlying profits to £1.1 billion.

Today's optimism is in contrast to 2016, when the company was forced into its first dividend cut in 24 years, and to last year's record loss of £4.6 billion. This stemmed from sterling's post-Brexit slump and settlements with prosecutors over bribery and corruption allegations relating to intermediaries.

Chief executive Warren East now appears to have got Rolls back on the right track, although he insisted today there's much work to be done in terms of tackling costs and reducing the complexity of the group.

His primary aim will be to get annual cash flows up from a paltry £100 million in 2016 to £1 billion in 2020, with further growth over the subsequent years.

Encouragingly, free cash inflow of £273 million in 2017 was much better than the £129 million expected by analysts before today, helped by higher profitability in civil aerospace, defence and power systems.

Growing free cash flow will not only help improve shareholder payments, but sustain investment in R&D programmes. Rolls plans to give more details of its capital allocation strategy at its Capital Markets event in June.

For 2017, Rolls-Royce has announced an unchanged full year dividend payment of 11.7 pence at a cost of £216 million.

Source: interactive investor      Past performance is not a guide to future performance

Consensus forecasts compiled prior to today's results show that analysts expect a dividend of 13.4p in respect of this year's trading, rising to 15.1p in 2019 and 17.3p in 2020. At the moment Rolls is trading with a dividend yield of 1.4%, although UBS analysts think this can improve to around 3% in 2020.

They have a 'buy' recommendation and £10 target price, adding that today's results represented a "major milestone" in the Rolls performance.

In January, East laid out plans for the simplification of the business from five to three operating businesses. He believes this will help the group act with greater pace, innovate in core technologies and better take advantage of future opportunities in areas such as electrification and digitalisation.

He expects a clearer focus on customers and markets going forward, particularly in widebody engines, where the company aims for a 50% share of the market.

However, significant in-service issues relating to the durability of a small number of parts for the Trent 1000 and Trent 900 engine programmes resulted in total charges of £227 million today.

The majority of the work will be undertaken in 2018 and 2019 although it is not expected to be fully complete until 2022. All of the costs are included in the company's cash flow guidance for 2018 and beyond.