bgf chisong rollsroyce

7/28/2019 BGF ChiSong RollsRoyce

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Rolls Royce Buy Recommendation

LSE: RR.

Chi Song

3/16/2013


2/69

Agenda

2

1) Introduction and investment thesis2) Industry overview

3) Barriers to entry

4) Revenue growth

5) Margin expansion6) Valuation

7) Risks and mitigants

8) Appendix


3/69

Agenda

3

1) Introduction and investment thesis2) Industry overview


4) Revenue growth



8) Appendix


4/69

Introduction to Rolls Royce

4

Closest to pure play aero engine/aero engine derivative maker Supplies 4 end markets, with the most important being civil

and defense aerospace

52%

20%

18%

8%

2%

-1%

51%

28%

21%

1%

8%

-9%

CIVIL DEFENSE MARINE ENERGY ENERGY

HOLDING

CORP/OTHER

BUSINESS BREAKDOWN, 2012 FY

Underlying Revenue Underlying Pretax Profit


5/69

Buy recommendation: investment thesis

5

1. Aero engines is an oligopoly with high barriers to entry

2. Poised to overtake GE as the worlds largest supplier ofwidebody aircraft engines, with 51% market share Drives conservatively projected EBITDA CAGR of ~9% to 2022

3. Potential for margin expansion via operating leverage

4. Return profile de-risked by conservative assumptions, defensiveindustry, and extensive firm order book Many call options (e.g. secular RPK growth that adds 5 GBP/share to

target price) remain that boosts return profile

Conservative assumptions yield 15 GBP target price (40% upside).

~1215% IRR with lower than equity risk for 310 years.


6/69

Current capitalization and valuation

6

Trades in London at 10.85 GBP/share

Trades at ~4.4% LTM UFCF yield on EV, including growth CapEx

Numbers from 2/22/2013Not materially different today

For your reference: I didnt bother changing number colors on my spreadsheet when pasting into the slide deck.

Blue & green numbers are inputs, purple are cross-sheets links.

CAPITAL STRUCTURE xEBITDA FCF Yield %

Security ap Stack LTM 2017E 2022E LTM 2017E 2022E

Debt 1,383.0 0.7x 0.4x 0.3x

Pension + RRSP 1,106.0

Total Debt 2,489.0 1.3x 0.8x 0.5x

(-) Excess Cash 2,585.0

Net Debt (96.0) 0.0x 0.0x 0.0x

Common Equity 20,306.9 Without incorporating cash build:

Enterprise Value 20,210.9 10.2x 6.4x 4.4x 4.4% 9.3% 14.3%

LTM 2017E 2022E Share DataEBITDA 1,977 3,143 4,574 Px/Sh. 10.9

UFCF (Incl. all CapEx) 889 1,876 2,885 S/O (M) 1,871.6

Cash Build 7,931 19,965


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Agenda

7

1)Introduction and investment thesis

2) Industry overview


4) Revenue growth



8) Appendix


8/69

Thesis focuses on Civil segment

8

52%

20%

18%

8%

2%

-1%

51%

28%

21%

1%

8%

-9%

CIVIL DEFENSE MARINE ENERGY ENERGY

HOLDING

CORP/OTHER

BUSINESS BREAKDOWN, 2012 FYUnderlying Revenue Underlying Pretax Profit


9/69

Civil aero engine industry

9

Business: Design, supply, and service aircraft engines

Engines are usually the largest part of an airplanes cost

End buyers: Airlines, aircraft leasing firms, corporations, governments,

private individuals, etc.

Airframe OEM decides whether there will be a choice of engine

End buyers decide on which engine to purchase if there is choice

Three segments:

WidebodyCommercial Airbus/Boeing dual aisle frames (e.g. B787)

NarrowbodyCommercial single aisle frames, mainly Airbus/Boeing

Regional/CorporateSmaller airframes, includes Embraer, Bombardier,

and Gulfstream


10/69

Aero engine industry structure is heavily

consolidated, with three major players

10

GE AviationIndustry leader $19B 2011 revenues

$3.5B 2011 operating income

Pratt & WhitneyUTX subsidiary

$13.4B 2011 revenues $2B 2011 operating income

Rolls Royce

12.2B GBP 2012 revenues

1.4B GBP 2012 operating income Oligopoly structure since 1970s

All three have hundred-year histories


11/69

Other aero engine industry competitors are

JVs of 3 majors due to high barriers to entry

11

CFM50/50 JV between GE and Snecma of SAFRAN Group 75% share in unfilled narrowbody orders

Engine Alliance50/50 JV between GE and P&W, founded in

2001 to produce the GP7200 for the A380 program

International Aero EnginesInitially formed as a JV between

P&W (17%), RR (32.5%), Japanese Aero Engine (25.25%), and

MTU Aero Engine (25.25%) to produce V2500 for A320 RR sold stake in IAE for 1.5B GBP + earnout to P&W in 10/2011


12/69

Airframe and engine OEM relationships: The

A350 story

12

Airframe OEMs not powerful relative to engine OEMs

Airbus couldnt get P&W or GE to offer an engine for its A350

GE afraid of cannibalizing B777 (competitor to A350) sales, on

which GE90 is exclusive for 200LR and 300ER models P&W focused on geared turbofan (GTF) technology, which

primarily powers smaller aircraft

Airbus ended up making Trent XWB the exclusive engine toincentivize RR to redesign the engine for the A350-1000

Leahy (Airbus COO) notes that although Airbus usually wants

two engines, having only the Trent hasnt hurt sales


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Business models in the aerospace industry

tend to focus on aftermarket

13

Engines are highly engineered, long-lived assets (useful livesover 20 years) that require extensive specialized maintenance

End buyers contract separately with engine OEM for maintenance

Resulting business model: razor/blade Engine OEM makes no margin or loss on OE business

Aftermarket business often 3x OE cost with margins of >40%

ImplicationInstalled base drives profitability


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Services drive most of Rolls Royces revenue

base and a larger share of income

14


15/69

The Rolls Royce model: TotalCare (LTSA)

15

Power by the Hour model

End customer pays a contracted fee per flying hour

RR bears all subsequent maintenance costs, which drives lumpy

cashflows (see graphic below)

Graphic source: RR 2012 FY presentation


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LTSAs value proposition

16

To customers:

Predictable costsfailure risks transferred to OEM

Flexible contract design

Better matching of load and capacityManage time and type of

maintenance for customers benefit

Optimized systemson-wing engine monitoring by OEM allows

for rapid response and maximized uptime

To Rolls Royce:

Opportunity for margin expansion from learning curve

Aligns failure risk to OEM

Optimizes shop loadingRR manages maintenance schedules


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Agenda

17

1) Introduction and investment thesis



4) Revenue growth



8) Appendix


18/69

The aero engine business has the indicators

of high barriers to entry

18

Stable oligopoly structure for decades

High, stable ROAs and margins

Given LTSA model, ROICs magnified by high float

RR consolidated average ROIC 2006 - 2012 is 34%

Barriers to Entry Key Stats

Fiscal Year Ending Dec. 31st,

2007 2008 2009 2010 2011 2012

Aero Engine Segment ROA

Rolls Royce 10.9% 10.5% 9.2% 8.8% 7.4% 8.8%

GE Aviation N/A N/A 19.3% 15.6% 14.9% 14.9%

Pratt & Whitney 21.1% 21.0% 19.0% 19.6% 17.5% 10.6%

Aero Engine Segment EBITDA Margins

Rolls Royce 13.7% 13.6% 13.0% 13.3% 14.7% 16.4%

GE Aviation N/A N/A 23.8% 22.0% 21.6% 22.0%

Pratt & Whitney 21.1% 21.0% 19.0% 19.6% 17.5% 10.6%


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Aero engine industry features nearly

insurmountable barriers to entry

19

Partners would be extremely wary of new entrants

Airframe OEMs (Airbus, Boeing, Bombardier, Embraer, etc.) must

design the aircraft to integrate with the engine

End customers require decades of service from the engine OE

Installed base faces extremely high switching costs

Cost prohibitive for customers to replace engines

Incumbents have extensive IP and industry know-how E.g. RR won 475 new patents in 2011 alone


20/69

Key barrier to entry: Entrants require

billions of capital with the capacity to suffer

20

Engine projects require billions of R&D on top of accumulated IP

years in advance of the first delivery E.g. Trent XWB project for A350 launched in 2004, and the first A350

will not be delivered until 2014

The entrant must be prepared to build and deliver engines atbreakeven or a loss

Acquiring plant, facilities, and industry-know how require further billionsof capital investment

Engine project will not be profitable for years after delivery untilaftermarket revenues begin kicking in

Most engines are delivered on 5 years warranty

Breakeven point up to two decades after R&D program launch


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Key barrier to entry: Economies of scale

21

R&DLarge R&D budgets required to maintain technologicalcompetitiveness; easier to amortize over large revenue base

RR does ~600M of self-funded R&D (4.9% of revenues)

Service facilitiesAero engines require a worldwidemaintenance facility presence

GE has 12 Maintenance, Repair and Overhaul (MRO) shops RR has 14 MRO shops worldwide

Employees

Compensationis ~30% of RRs

cost base


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Agenda

22




4) Revenue growth



8) Appendix


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Category

Manufac-

turer Model

Produc-

tion Yrs.

In Prod-

uction?

# of

Engines

# of

Seats

Opera-

ting*

Unfilled

Orders

Total

Orders Engine 1

Engine 1

Provider

Engine 1

Sh are E ngin e 2

Engine 2

Provider

Engine 2

Sh are E ng in e 3

Engine 3

Provider

Engine 3

Share

Wide Boeing 787 2011 Yes 4 290 - 330 49 792 841 GEnx GE 59%

Trent

1000

Rolls

Royce 41% N/A N/A N/A

Wide Airbus A350 2013 Yes 2 250 - 300 0 592 592

Trent

XWB

Rolls

Royce 100% N/A N/A N/A N/A N/A N/A

Wide Boeing

777F and

300ER 2004 Yes 2 386 - 550 445 353 798 GE90 GE 100% N/A N/A N/A N/A N/A N/A

Wide Airbus A330 1992 Yes 2 335 931 307 1244 Trent 700

Rolls

Royce 57% PW4000

Pratt &

Whitney 21% CF6 GE 22%

Wide Airbus A380 2007 Yes 4 525 - 853 97 165 262 GP 7200

Engine

Alliance 56% Trent 900

Rolls

Royce 44% N/A N/A N/A

Wide Boeing 767 1982 Yes 2 190 - 210 1041 67 1108 JT9DPratt &

Whitney N/A CF6 GE N/A N/A N/A N/A

Wide Boeing 747 1970 Yes 4 366 - 660 1458 67 1525 Various GE and Pratt & Whitney engines N/A N/A N/A

Wide Boeing

777-

200/300 1993 Yes 2 314 - 550 621 12 633 GE90 GE 60% Trent 800

Rolls

Royce 40% PW4000

Pratt &

Whitney N/A

Wide Airbus A340

1993 -

2011 No 4 375 - 440 362 0 377 Trent 500

Rolls

Royce

100% ('02-

'11)

CFM 56-

5C CFM

100% ('92-

'02) N/A N/A N/A

Wide Airbus A310

1982 -

2007 No 2 218 - 280 166 0 255 PW4000

Pratt &


Wide Airbus A300

1974 -

2007 No 2 226 312 0 561 PW4000

Pratt &


RR poised to take leadership in widebody

engines, driven by A350 exclusivity

23

GE will deliver 2,975 engines on current firm order book

RR will deliver 3,133 engines on current firm order book

Trent XWB: 100% share on A350, enters service 2014

Trent 1000: 41% share on B787, Boeing ramping production

Trent 900: 44% share on A380, production ramping as well


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Civil OE revenues will CAGR at 7% for next

10 years as production ramps

24 Note: All projections include a 2% global inflation adjustmentNote: Engine costs are guesstimates at best; actual prices are a carefully guarded secret

Civil Aero OE Revenues Build


2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

A330 Production 108 120 132 132 132 120 108 96 96 96 96

RR Share of A330 65% 57% 57% 57% 57% 57% 57% 57% 57% 57% 57%

Trent 700 (A330) Deliveries 140 137 150 150 150 137 123 109 109 109 109

Est. Cost per Engine (72k k-lbs. Thrust) 5.9 6.1 6.2 6.3 6.4 6.6 6.7 6.8 7.0 7.1 7.2

Trent 700 Revenues 832 829 930 949 968 897 824 747 762 777 792

A380 Production 30 35 35 35 35 35 35 30 25 25 25

RR Share of A380 53% 44% 44% 44% 44% 44% 44% 44% 44% 44% 44%

Trent 900 (A380) Deliveries 64 62 62 62 62 62 62 53 44 44 44


Trent 900 Revenues 549 539 550 561 572 584 595 520 442 451 460

B787 Production 46 65 120 120 120 120 120 120 120 120 120

RR Share of B787 21% 41% 41% 41% 41% 41% 41% 41% 41% 41% 41%

Trent 1000 (B787) Deliveries 38 107 197 197 197 197 197 197 197 197 197


Trent 1000 Revenues 226 646 1,216 1,241 1,265 1,291 1,316 1,343 1,370 1,397 1,425

A350 Production 10 30 52 78 102 120 132 132 132

RR Share of A350 100% 100% 100% 100% 100% 100% 100% 100% 100%

Trent XWB (A350) Deliveries 20 60 104 156 204 240 264 264 264

Est. Cost per Engine (86k k-lbs. Thrust) 5.8 5.9 6.0 6.1 6.3 6.4 6.5 6.6 6.8

Trent XWB Revenues 116 353 625 956 1,275 1,530 1,717 1,751 1,786

Other Engine Deliveries 630 630 630 630 630 630 630 630 630 630 630

Est. Cost per Engine 2.1 2.1 2.1 2.2 2.2 2.3 2.3 2.4 2.4 2.5 2.5

Total Other OE Revenues 1,293 1,318 1,345 1,372 1,399 1,427 1,456 1,485 1,514 1,545 1,576

Civil Aero OE Underlying Revenues 2,934 3,332 4,156 4,475 4,829 5,154 5,466 5,625 5,805 5,921 6,040

Less: Gross Additions to Recoverable Engine Costs (35) (152) (189) (203) (220) (234) (249) (256) (264) (269) (275)

As % of Civil Aero OE Underlying Revenues -1.2% -4.5% -4.5% -4.5% -4.5% -4.5% -4.5% -4.5% -4.5% -4.5% -4.5%

Civil Aero OE Underlying Revenues, Net of Loss at OE 2,899 3,181 3,967 4,272 4,609 4,920 5,218 5,369 5,541 5,652 5,765

Growth, YoY 38.2% 9.7% 24.7% 7.7% 7.9% 6.7% 6.0% 2.9% 3.2% 2.0% 2.0%

CAGR from 2012 9.7% 17.0% 13.8% 12.3% 11.2% 10.3% 9.2% 8.4% 7.7% 7.1%


25/69

Service revenues CAGR at 10% for next 10

years as Trent installed base CAGRs at 13%

25

Trent installed base grows 3.3x as RR takes lead on widebody

Attrition from older, RB211 installed base a slight drag

Corporate and regional installed base expected to mature

Note: All projections include a 2% global inflation adjustment

Civil Aero Services Revenues Build


2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Trent Installed Base 2,212 2,507 2,926 3,385 3,888 4,429 5,004 5,593 6,198 6,802 7,406

Trent Base Attrition, Units/Yr (Primarily Trent 800 Retiremen 10 10 10 10 10 10 10 10 10 10 10

Trent Base Growth 11.7% 13.3% 16.7% 15.7% 14.9% 13.9% 13.0% 11.8% 10.8% 9.7% 8.9%

CAGR from 2012 13.3% 15.0% 15.2% 15.1% 14.9% 14.6% 14.2% 13.7% 13.3% 12.8%

Revenue per Installed Engine 0.87 0.89 0.91 0.92 0.94 0.96 0.98 1.00 1.02 1.04 1.06

Trent Service Revenues 1,927 2,227 2,651 3,129 3,665 4,259 4,909 5,596 6,325 7,080 7,863

Trent as % of Civil Aero Service Revenues 55% 59% 63% 67% 71% 74% 77% 80% 82% 84% 85%

RB211 Installed Base 1,839 1,729 1,608 1,479 1,346 1,211 1,078 949 825 710 603

RB211 Net Growth -5% -6% -7% -8% -9% -10% -11% -12% -13% -14% -15%


RB211 Service Revenues 701 672 637 598 555 510 463 415 368 323 280

RB211 as % of Civil Aero Service Revenues 20% 18% 15% 13% 11% 9% 7% 6% 5% 4% 3%

Corporate and Regional Installed Base 8,449 8,449 8,449 8,449 8,449 8,449 8,449 8,449 8,449 8,449 8,449

Corporate and Regional Net Growth 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%


Corporate and Regional Service Revenues 876 893 911 929 948 967 986 1,006 1,026 1,047 1,068

Corp. and Regional as % of Civil Aero Service Revenues 25% 24% 22% 20% 18% 17% 16% 14% 13% 12% 12%

Civil Aero Service Revenues 3,503 3,792 4,200 4,656 5,168 5,735 6,357 7,017 7,719 8,450 9,211

Growth, YoY 4.9% 8.3% 10.7% 10.9% 11.0% 11.0% 10.8% 10.4% 10.0% 9.5% 9.0%

CAGR from 2012 8.3% 9.5% 9.9% 10.2% 10.4% 10.4% 10.4% 10.4% 10.3% 10.2%


26/69

Agenda

26




4) Revenue growth



8) Appendix


27/69

Segment margins have room to improve

27

RR historically posts lowest margins of peer group due tooperational inefficiencies, lack of scale, and LTSA accounting

Margin recognition improves as LTSA contracts mature

RR features 27.5% EBITDA margins on service in 2012(assuming 0% OE margins)

GE likely does 40-50% EBITDA margins on service RR can gain GEs scale as it overtakes GE in widebody

GEs narrowbody business is the CFM JV

2007 2008 2009 2010 2011 2012

Aero Engine Segment EBITDA Margins

Rolls Royce 13.7% 13.6% 13.0% 13.3% 14.7% 16.4%

GE Aviation N/A N/A 23.8% 22.0% 21.6% 22.0%

Pratt & Whitney 21.1% 21.0% 19.0% 19.6% 17.5% 10.6%


28/69

Differences between RR margins and GE

margins driven by scale and operations

28

RR management notes that the margin differential between RR

and GE is largely driven by scale and supply chain

ScaleLower unit volume in a high fixed cost business (esp.

maintenance) drives lower margins

Supply chainRR historically has a highly fragmented supply

chain (many parts sourced from small, diverse UK suppliers)

and receives terms worse than those GE received

E.g. RB211 (legacy engine) had >500 suppliers, Trent 800 had ~400,

and Trent XWB now has ~75


29/69

Aero engines is a high operating leverage

business with extensive fixed costs

29

30% of the cost structure easily identified as components that can

provide operating leverage (see table below) Many more fixed costs are likely embedded in the business

Management spent past years building out infrastructure (service

centers, training, etc.) to support rapid growth in Trent installed base Incremental margin study suggests 22% of costs over past 5 years are

fixed; this is a floor going forward given fixed costs were ramping tosupport Trent

Cost Structure Decomposition

Corporate Segment 43 32 39 68 55 49 61

Net R&D 370 381 403 379 422 463 589Employees 37,300 38,600 39,000 39,000 38,500 38,900 40,400

Group Revenue per Employee 197,131 202,513 234,538 259,179 282,234 289,897 302,203

Employment Costs 1,795 1,990 2,087 2,087 2,213 2,330 2,364

Total Group Identfiable Non-Pure Variable Costs 2,208 2,403 2,529 2,534 2,690 2,842 3,014

As % of Group Costs 34.4% 35.4% 31.8% 28.5% 28.2% 29.3% 29.3%

Total Group Underlying Costs Excl. D&A 6,416 6,784 7,952 8,878 9,544 9,710 10,293


30/69

Service revenue growth and operating

leverage drive 12% EBITDA CAGR to 2022

30

Conservative assumptions

60% of civil aero service costs assumed variable

BAML: 50% of service costs variable

34% underlying service EBITDA margin projected in 2022, which

is still significantly below GE level

Civil Aero EBITDA Build


2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Civil Aero OE Revenues, Incl. Capitalized Loss 2,899 3,181 3,967 4,272 4,609 4,920 5,218 5,369 5,541 5,652 5,765

Civil Aero Service Revenues 3,503 3,792 4,200 4,656 5,168 5,735 6,357 7,017 7,719 8,450 9,211

Civil Aero Service as % of Total Civil Aero Revenues 54.7% 54.4% 51.4% 52.2% 52.9% 53.8% 54.9% 56.7% 58.2% 59.9% 61.5%

Total Civil Aero Revenues 6,402 6,973 8,167 8,927 9,778 10,656 11,575 12,387 13,260 14,102 14,976

Growth, YoY 17.7% 8.9% 17.1% 9.3% 9.5% 9.0% 8.6% 7.0% 7.1% 6.3% 6.2%

Revenue CAGR from 2012 8.9% 12.9% 11.7% 11.2% 10.7% 10.4% 9.9% 9.5% 9.2% 8.9%

Civil Aero OE EBITDA, Incl. Capitalized Loss - - - - - - - - - - -

Civil Aero IAE Earnout 92 185 185 185 185 185 185 185 185 185 185

Civil Aero Service EBITDA 963 1,090 1,250 1,441 1,629 1,839 2,070 2,319 2,585 2,863 3,153

Civil Aero Service EBITDA Margin % 27.5% 28.7% 29.8% 31.0% 31.5% 32.1% 32.6% 33.1% 33.5% 33.9% 34.2%

Civil Aero EBITDA 1,055 1,275 1,435 1,626 1,814 2,024 2,255 2,504 2,770 3,048 3,338

Underlying EBITDA Margin %, Excl. Earnout 15.0% 15.6% 15.3% 16.1% 16.7% 17.3% 17.9% 18.7% 19.5% 20.3% 21.1%

EBITDA CAGR from 2012 20.8% 16.6% 15.5% 14.5% 13.9% 13.5% 13.1% 12.8% 12.5% 12.2%


31/69

Growth in Civil Aero segment alone would

drive 9% EBITDA CAGR to 2022

31 Note: All projections include a 2% global inflation adjustment

Consolidated EBITDA Build


2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

OE Revenues

Civil Aero, Net of Loss at OE 2,899 3,181 3,967 4,272 4,609 4,920 5,218 5,369 5,541 5,652 5,765

Defense 1,231 1,256 1,281 1,306 1,332 1,359 1,386 1,414 1,442 1,471 1,501

Marine 1,288 1,314 1,340 1,367 1,394 1,422 1,450 1,480 1,509 1,539 1,570

Energy 344 351 358 365 372 380 387 395 403 411 419

Consolidated OE Revenues 5,762 6,101 6,946 7,310 7,708 8,081 8,442 8,658 8,896 9,073 9,255

OE Revenues as % of Total 47.9% 48.0% 49.5% 49.1% 48.6% 47.9% 47.1% 45.9% 44.8% 43.6% 42.4%

Service Revenues

Civil Aero 3,503 3,792 4,200 4,656 5,168 5,735 6,357 7,017 7,719 8,450 9,211

Defense 1,186 1,210 1,234 1,259 1,284 1,309 1,336 1,362 1,390 1,417 1,446

Marine 961 980 1,000 1,020 1,040 1,061 1,082 1,104 1,126 1,148 1,171

Energy 618 630 643 656 669 682 696 710 724 739 753Consolidated Service Revenues 6,268 6,613 7,076 7,590 8,161 8,788 9,471 10,193 10,959 11,754 12,582

OE Revenues as % of Total 52.1% 52.0% 50.5% 50.9% 51.4% 52.1% 52.9% 54.1% 55.2% 56.4% 57.6%

Energy Holdings Revenues 3,006 3,066 3,127 3,190 3,254 3,319 3,385 3,453 3,522 3,592

Consolidated Revenues 12,030 15,720 17,089 18,027 19,060 20,123 21,232 22,237 23,307 24,350 25,429

Revenue Growth 9.1% 30.7% 8.7% 5.5% 5.7% 5.6% 5.5% 4.7% 4.8% 4.5% 4.4%

EBITDA Margins

Civil Aero 16.5% 18.3% 17.6% 18.2% 18.6% 19.0% 19.5% 20.2% 20.9% 21.6% 22.3%

Defense 19.1% 19.1% 19.1% 19.1% 19.1% 19.1% 19.1% 19.1% 19.1% 19.1% 19.1%

Marine 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8%

Energy 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5%

EBITDA Contribution

Civil Aero 1,055 1,275 1,435 1,626 1,814 2,024 2,255 2,504 2,770 3,048 3,338

Defense 460 470 479 489 498 508 519 529 540 550 561

Marine 355 362 369 377 384 392 400 408 416 424 433

Energy 63 64 65 66 68 69 71 72 73 75 76

Energy Holding (50% Consolidated) 109 205 209 213 218 222 226 231 235 240 245

Corporate (65) (66) (68) (69) (70) (72) (73) (75) (76) (78) (79)

Consolidated EBITDA 1,977 2,309 2,490 2,702 2,912 3,143 3,397 3,669 3,958 4,260 4,574

EBITDA Margin % 16.4% 18.2% 17.8% 18.1% 18.3% 18.6% 19.0% 19.5% 19.9% 20.5% 20.9%

EBITDA Growth 22.3% 16.8% 7.8% 8.5% 7.7% 8.0% 8.1% 8.0% 7.9% 7.6% 7.4%

EBITDA CAGR from 2012 16.8% 12.2% 11.0% 10.2% 9.7% 9.4% 9.2% 9.1% 8.9% 8.8%


32/69

RR generates robust free cash flow as

growth ramps

32

RR to generate 85% of current EV in free cash in next 10 years

Assumes no change in debt financing, rising asset utilization to a level still significantly below P&W/GE, and decreasing invested capital as % of assetsdriven by increasing LTSA float financing.

Company features negative net working capital position, so working capital has been excluded from FCF calculations.

Earnings Bridge


2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Consolidated Underlying EBITDA 1,977 2,309 2,490 2,702 2,912 3,143 3,397 3,669 3,958 4,260 4,574

EBITDA CAGR from 2012 16.8% 12.2% 11.0% 10.2% 9.7% 9.4% 9.2% 9.1% 8.9% 8.8%

Less: D&A (487) (593) (632) (657) (686) (715) (744) (769) (796) (821) (847)

Less: Taxes (318) (395) (427) (470) (512) (559) (610) (667) (727) (791) (857)

Unlevered Underlying Earnings 1,172 1,321 1,431 1,575 1,714 1,870 2,043 2,233 2,435 2,648 2,870Less: Underlying Finance Costs (61) (61) (61) (61) (61) (61) (61) (61) (61) (61) (61)

Add: Interest Tax Shield 14 14 14 14 14 14 14 14 14 14 14

Levered Underlying Earnings 1,125 1,274 1,384 1,528 1,667 1,823 1,996 2,186 2,388 2,601 2,823

FCF Bridge


2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Underlying Unlevered Earnings 1,172 1,321 1,431 1,575 1,714 1,870 2,043 2,233 2,435 2,648 2,870

Less: Additional Invested Capital Required (664) (343) (338) (226) (250) (253) (260) (222) (236) (222) (227)

Memo: Projected CapEx & Other WC Investments (795) (762) (722) (612) (637) (647) (663) (642) (674) (685) (716)

Memo: Projected Increase in TCA Debtor (356) (175) (248) (272) (298) (321) (341) (349) (358) (358) (358)

Unlevered Free Cash Flow 508 978 1,093 1,348 1,464 1,617 1,782 2,011 2,198 2,426 2,643

Less: Underlying Financing Costs, Net of Tax Shield (47) (47) (47) (47) (47) (47) (47) (47) (47) (47) (47)

Levered Free Cash Flow 461 931 1,046 1,301 1,417 1,570 1,735 1,964 2,151 2,379 2,596


33/69

Agenda

33




4) Revenue growth



8) Appendix


34/69

Growth story de-risked by defensible

industry and extensive firm order book

34

Industry effectively impermeable to new entrants, ensuring

business stability

60B GBP firm order book (5 years of revenues)

Backlog and Other


2006 2007 2008 2009 2010 2011 2012

Backlog by Segment (Bil. GBP)

Civil Aerospace 20.0 35.9 43.5 47.0 48.5 51.9 49.6

Defence Aerospace 3.2 4.4 5.5 6.5 6.5 6.0 5.2

Marine 2.4 4.7 5.2 3.5 3.0 2.7 4.0

Energy 0.5 0.9 1.3 1.3 1.2 1.5 1.3

Total Backlog 26.1 45.9 55.5 58.3 59.2 62.1 60.0

Years' of Revenue in Backlog

Civil Aerospace 5.4 9.0 9.9 10.8 10.1 9.5 7.7

Defence Aerospace 2.0 2.6 3.3 3.2 3.1 2.7 2.1

Marine 1.8 3.0 2.4 1.4 1.2 1.2 1.8

Energy 1.0 1.6 1.7 1.3 1.0 1.4 1.3

Consolidated Average 3.5 5.9 6.1 5.8 5.4 5.5 4.9


35/69

Conservative valuation assumptions leave

robust margin of safety

35

Projects no improvement in other segments

Consensus view is that Marine, Energy, and Energy Holdings

segment will grow significantly and expand margins as well

Civil aero margin expansion opportunities not exhausted

34% 2022 projected service EBITDA margins still lags peers

Project 60% of civil service costs variable; BAML assumes ~40%

No tailwind from RPK growth projected (adds 5 GBP/share) BA projects 5% RPK CAGRs

Regression of civil service revenues vs. RPK (revenue passenger

kilometers) from 20062011 has a 99% r-squared


36/69

LTSAs de-risk and annuitize cash flows,

supporting lower cost of capital

36

Civil Service expands to become the vast majority of EBITDA

90% of Civil Service revenues to be covered by LTSAs

LTSAs annuitizes cash flows, provide float, reduce risk

Civil aerospace sector is inherently defensive

42%

26%

13% 18%

73%

0%

12% 15%

0%

20%

40%

60%

80%

Civil Service Civil OE Defense Other

% of Firm, 2022 FY

Underlying Revenue Underlying EBITDA


37/69

and future growth opportunities should

sustain or grow multiples

37

Capital structure efficiency opportunities

Annuitized LTSA cash flows will support robust leverage

Firm currently unlevered, while peer UTX features 2.4x leverage

Opportunity to use larger scale and resource base to competefor next-gen narrowbody market

Long-term, secular RPK growth

Historically, RPK has grown at global GDP + 1.5 to 2% Emerging markets drive installed base growth

f l b f


38/69

Return profiles are robust even if exiting at

LTM EBITDA multiples

38

~12% to ~15% holding period returns between 3 and 10 year

investment horizons

Assumes 2% global inflation, but RR protects well against higher

inflation given pricing power in oligopoly business

2015E Exit: 2017E Exit: 2022E Exit:

Accumulated LFCF 3,419 Accumulated LFCF 6,265 Accumulated LFCF 17,090

Add: Exit at LTM EV/EBITDA 27,628 Add: Exit at LTM EV/EBITDA 32,132 Add: Exit at LTM EV/EBITDA 46,761

Realized Profits 31,046 Realized Profit 38,397 Realized Profits 63,851

Current EV 20,211 Current EV 20,211 Current EV 20,211

Holding Period (Years) 3 Holding Period (Years) 5 Holding Period (Years) 10

IRR 15.4% IRR 13.7% IRR 12.2%

C d i i i i f


39/69

DCF and sensitivity suggest target price of

16 GBP with robust margin of safety

39

10% discount rate very conservative for defensible business and firm orders

Current share price robust to multiple compressionDCF


2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

UFCF 978 1,093 1,348 1,464 1,617 1,782 2,011 2,198 2,426 2,643

Exit Multiple (xEBITDA) 10.2

Exit Value 46,761

WACC 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

Discount Period 0.8 1.8 2.8 3.8 4.8 5.8 6.8 7.8 8.8 9.8

Discounted Cash Flows 910 925 1,037 1,024 1,028 1,030 1,057 1,050 1,054 19,506

Sum of Discounted Cash Flows 28,622

Less: Net Debt (Cash) (96)

Equity Value 28,526

Equity Value per Share (GBP) 15.2 40.5% Upside

DCF Sensitivity, Discount Rate (Column) vs. EV/EBITDA Exit Multiple (Row)

15.2 6.0x 6.5x 7.0x 7.5x 8.0x 8.5x 9.0x 9.5x 10.0x

8.0% 12.9 13.4 14.0 14.6 15.2 15.8 16.3 16.9 17.5

8.5% 12.4 13.0 13.5 14.1 14.6 15.2 15.7 16.3 16.8

9.0% 12.0 12.5 13.0 13.6 14.1 14.6 15.1 15.7 16.2

9.5% 11.6 12.1 12.6 13.1 13.6 14.1 14.6 15.1 15.6

10.0% 11.2 11.6 12.1 12.6 13.1 13.6 14.1 14.5 15.0

10.5% 10.8 11.2 11.7 12.2 12.6 13.1 13.6 14.0 14.5

11.0% 10.4 10.9 11.3 11.7 12.2 12.6 13.1 13.5 14.0

11.5% 10.1 10.5 10.9 11.3 11.8 12.2 12.6 13.0 13.5

12.0% 9.7 10.1 10.5 11.0 11.4 11.8 12.2 12.6 13.0

F h i i i l b


40/69

Further sensitivity analyses suggest robust

margin of safety against key assumptions

40

DCF Sensitivity, Discount Rate (Column) vs. Variable Cost % in Civil Aero Service (Row)

15.2 80.0% 75.0% 70.0% 65.0% 60.0% 55.0% 50.0% 45.0% 40.0%8.0% 13.5 14.5 15.6 16.7 17.7 18.8 19.9 20.9 22.0

8.5% 13.0 14.0 15.0 16.0 17.1 18.1 19.1 20.1 21.2

9.0% 12.5 13.5 14.5 15.5 16.4 17.4 18.4 19.4 20.4

9.5% 12.0 13.0 13.9 14.9 15.8 16.8 17.7 18.7 19.6

10.0% 11.6 12.5 13.4 14.3 15.2 16.2 17.1 18.0 18.9

10.5% 11.2 12.1 12.9 13.8 14.7 15.6 16.4 17.3 18.2

11.0% 10.8 11.6 12.5 13.3 14.2 15.0 15.8 16.7 17.5

11.5% 10.4 11.2 12.0 12.8 13.6 14.5 15.3 16.1 16.9

12.0% 10.1 10.8 11.6 12.4 13.2 13.9 14.7 15.5 16.3

IRR Sensitivity, Variable Cost % in Civil Service (Column) vs. EV/EBITDA Exit Multiple (Row)

0.2 6.0x 6.5x 7.0x 7.5x 8.0x 8.5x 9.0x 9.5x 10.0x

40.0% 1.8% 4.1% 6.3% 8.4% 10.4% 12.4% 14.3% 16.1% 17.8%

45.0% 1.2% 3.4% 5.6% 7.7% 9.7% 11.6% 13.5% 15.3% 17.1%

50.0% 0.5% 2.7% 4.9% 6.9% 8.9% 10.9% 12.7% 14.5% 16.3%55.0% -0.2% 2.0% 4.1% 6.2% 8.2% 10.1% 11.9% 13.7% 15.5%

60.0% -1.0% 1.3% 3.4% 5.4% 7.4% 9.3% 11.1% 12.9% 14.6%

65.0% -1.7% 0.5% 2.6% 4.7% 6.6% 8.5% 10.3% 12.1% 13.8%

70.0% -2.4% -0.2% 1.9% 3.9% 5.8% 7.7% 9.5% 11.3% 13.0%

75.0% -3.2% -1.0% 1.1% 3.1% 5.0% 6.9% 8.7% 10.4% 12.1%

80.0% -3.9% -1.8% 0.3% 2.3% 4.2% 6.0% 7.8% 9.6% 11.2%

U d iti 5% RPK th d i IRR f


41/69

Underwriting 5% RPK growth drives IRRs of

15-18% and adds 5 GBP/sh. (87% upside)

41

5% RPK CAGR, per BA projections over next 20 years, drives

a 15% CAGR in civil service revenues from 2012

Consolidated EBITDA CAGR would improve 3.4% to 2012,

adding 5 GBP/share of value

Key takeaway: RPK growth a major secular driver that remains

a call option on my current, conservative valuation2015E Exit: 2017E Exit: 2022E Exit:

Accumulated LFCF 3,487 Accumulated LFCF 6,644 Accumulated LFCF 20,639Add: Exit at LTM EV/EBITDA 29,536 Add: Exit at LTM EV/EBITDA 36,710 Add: Exit at LTM EV/EBITDA 66,197

Realized Profits 33,023 Realized Profit 43,354 Realized Profits 86,836

Current EV 20,211 Current EV 20,211 Current EV 20,211

Holding Period (Years) 3 Holding Period (Years) 5 Holding Period (Years) 10

IRR 17.8% IRR 16.5% IRR 15.7%


42/69

Agenda

42




4) Revenue growth



8) Appendix


43/69


44/69

Defense sequestration

44

Management expects a period of sequestration (2012 FY call)

Defense portfolio largely driven by A400M, F-35, and

Eurofighter, where cuts have already gone down (e.g. UK SDR)

Potential for sequestration reductions may be limited

Only F-35, Global Hawk, and V-22 Osprey are US programs

49% of defense revenues from service, not OE

Note: I am not a defense analyst, so I guarantee errors in the foregoing!

Type Engine RR Stake

~Unfilled

Orders

Transport TP400 28%

>174

Core

Combat

Lift-

system 100% >340

Combat EJ200 34% 140Helis RTM322 50% ~150

Transport AE1107C 100% 98

Transport AE2100 100% ~40

Helis MTR390 50% ~70

Transport AE3007 100% Few

Combat F136 40% 0

Eurofighter Typhoon

Status

Production rate cut by almost 50% in 2012; currently in Tranche 3 orders

Platform

A400M

7.6B EUR program, created by treaty -- any more cuts from core countries (France/Germany) below 170

orders will threaten the program. Cuts appear to have already happened

F35-B JSF STOVL Variant

Massive fighter program, with enormous potential (>2k JSFs in US alone), but equally scary cost/cost

overruns. Highly susceptible to cuts; under pressure already. STOVLs are perhaps 10-20% of orders.

F35

In JV with GE to produce an alternative to P&W's F135. Funding pulled by Congress in 2011; GE and RR are

continuing to fund some R&D since they believe funding will return, just at a lower level.

NHI NH90 Stressed program due to order cutbacks and late deliveries.

V22 Osprey Cut from 122 in early 2012

C130 J Hercules / C-27 ~900 engines delivered. Producing at about 24/year, with rate going down

Global Hawk Very expensive program that might be mothballed.

Eurocopter Tiger

Joint ~7.3B German/French program; some cuts have gone down in 2012, but Eurocopter doesn't expect

more cuts.

Ci il i hi hl l t d t


45/69

Civil service revenues highly correlated to

global commercial air activity

45

Regression of civil service revenues vs. RPK (revenue

passenger kilometers) from 20062011 has a 99% r-squared

RR therefore exposed to global air travel trends, but this

provides a tailwind over the long run

Per Boeing, over the next 20 years, RPKs will CAGR at 5%

RPKs historically grow at global GDP + 1.5-2.0%


46/69

Technical mishaps

46

Engines are vulnerable to technical issues, which cause losses

E.g. Trent 900/Qantas problem in 2010 caused loss of 56M GBP

Mitigants:

Engines are extensively tested; technical issues are far between Mishaps rarely cause long-term damage to the business:

Existing customers and firm orders face high switching costs

Most airframes have at most 2 options, and designing another option

takes many years

OEMs move quickly to address problem and control fallout


47/69

Competing against GE: the 500lb gorilla

47

GEs advantages:

Larger scale trailing revenues 1.5x RRs

Deep pocketsGE Capital can finance customers, and GE hasbought exclusivity on airframes in the past

Mitigants: RRs success in this generation provides stability for at least next

two decades given long cycle nature of the business

Industry cannot consolidate to monopoly

B787 was originally planned as a GE exclusive, but customers revolted

Boeing and Airbus always try to put 2 engine options on each plane

RR is strategically important to Europe

Industry players share technology and resources via JVsgiven capitalintensivity of industry, no player has the resources to go it alone


48/69

What happened to narrowbody?

48

RR and P&W strategically split the market: RR focused on

widebody, P&W focused on narrowbody/regional

Neither actor had resources to pursue all market segments

Widebody smaller by units, but larger by $

Category

Manufac-

turer Model

Produc-

tion Yrs.

In Prod-

uction?

# of

Engines

# of

Seats

Opera-

ting*

Unfilled

Orders

Total

Orders Engine 1

Engine 1

Provider

Engine 1

Share Eng ine 2

Engine 2

Provider

Engine 2

Share

Narrow Boeing 737 NG 1997 Yes 2 110 - 210 4293 2010 6303

CFM56-

7B CFM 100% N/A N/A N/A

Narrow Airbus A320neo 2015 Yes 2 124 - 236 0 1878 1878 LEAP-X CFM 60%

PW1000

G

Pratt &

Whitney 40%

Narrow Airbus A3201988 -Now Yes 2 107 - 220 5234 1751 7153 Various CFM, PW, IAE engines

Narrow Boeing 737 MAX 2017 Yes 2 126 - 180 0 1180 1180 LEAP-X CFM 100% N/A N/A N/A

Narrow Comac C919 2014 Yes 2 300 - 400 0 340 340 LEAP-1C CFM 100% N/A N/A N/A

Narrow Irkut MS-21 2015 Yes 2 150 -212 0 241 241

PW1000

G

Pratt &

Whitney 100% N/A N/A N/A

Narrow Embraer 190/195 2002 Yes 2 70 - 130 908 185 1093 CF34 GE 100% N/A N/A N/A

Narrow

Bombar-

dier C-Series 2014 Yes 2 100 - 149 0 148 148

PW 1500

G

Pratt &

Whitney 100% N/A N/A N/A

Boeing Market Projections, 2012-2031

Size $ B Units

Large 280 790

Twin-aisle 2,080 7,950

Single-aisle 2,030 23,240

Regional Jets 80 2,020

Total 4,470 34,000

Complex financing section of income


49/69

Complex financing section of income

statement

49

Company hedges exchange rates; instruments reported at fair

value produces large fluctuations in IFRS financials

Pension interest cost and actual return on pension assets

reported in financing income/costs on income statement,

which drives large swings in net income

Must look through variability to underlying economics

Earnings quality concern: capitalized


50/69

Earnings quality concern: capitalized

recoverable engine costs

50

When engine OE sales generate a loss, they are occasionally

capitalized in a recoverable engine costs account underintangible assets

Logic: engine will generate aftermarket profit, so loss is an asset

Analysts concerned with the impact of this practice on quality ofearnings

Mitigants

Logic is sound, as engine OEMs are generally only profitable onthe aftermarket

Negligible against scale of operationsat peak in 2009, only 6.6%of Civil OE revenues

Reversed in 2012: amortization of capitalized costs now largerthan gross additions


51/69

Allegations of bribery

51

Serious Fraud Office (SFO) investigating RR for using

intermediaries to pay bribes in Indonesia and China

Investigation also involves other countries, and incidents dating

back 10 years

May result in a fine

E.g. BAE paid 286M in 2010 after allegations of bribery in Saudi

Arabia, Africa, and central Europe

Other examples: GE, Siemens, SK Engineering

Source: Various news reports and filings, e.g. http://www.bbc.co.uk/news/business-20622911http://www.mondaq.com/unitedstates/x/212138/Corporate+Crime/UK+Serious+Fraud+Office+Focuses+On+Overseas+Corruption+With+Rolls+Ro

yce+Investigation

Conclusion: robust growth protected by
http://www.bbc.co.uk/news/business-20622911http://www.mondaq.com/unitedstates/x/212138/Corporate+Crime/UK+Serious+Fraud+Office+Focuses+On+Overseas+Corruption+With+Rolls+Royce+Investigationhttp://www.mondaq.com/unitedstates/x/212138/Corporate+Crime/UK+Serious+Fraud+Office+Focuses+On+Overseas+Corruption+With+Rolls+Royce+Investigationhttp://www.mondaq.com/unitedstates/x/212138/Corporate+Crime/UK+Serious+Fraud+Office+Focuses+On+Overseas+Corruption+With+Rolls+Royce+Investigationhttp://www.mondaq.com/unitedstates/x/212138/Corporate+Crime/UK+Serious+Fraud+Office+Focuses+On+Overseas+Corruption+With+Rolls+Royce+Investigationhttp://www.bbc.co.uk/news/business-20622911


52/69

Conclusion: robust growth protected by

extensive moats drive de-risked returns

52

1. Business in an oligopoly with high barriers to entry

2. Long-cycle business with extensive firm order book drives highcertainty regarding growth: will overtake GE in widebody

3. Ample room for margin expansion via operating leverage

4. Return profile de-risked by conservative assumptions, defensiveindustry, and extensive firm order book

Many call options (e.g. secular RPK growth that adds 5 GBP/share totarget price) remain that boosts return profile

Conservative assumptions yield 15 GBP target price (46% upside).

~1215% IRR for 310 years with lower than equity risk.


53/69

Agenda

53




4) Revenue growth



8) Appendix


54/69

View vs. BAML

54

View vs. BAML

Fiscal Year Ending Dec. 31st, Comments

2013E 2014E 2015E 2016E

Civil Aero Non-IAE Revenues

BAML OE 3,274 3,842 4,335 4,661 Unit installed base growth nearly identical.Projected OE 3,181 3,967 4,272 4,609

Divergence -2.8% 3.3% -1.5% -1.1%

BAML Service 3,005 3,151 3,476 3,752

Projected Service 3,792 4,200 4,656 5,168

Divergence 26.2% 33.3% 33.9% 37.7%

BAML Consolidated 6,279 6,993 7,811 8,413

Projected Consolidated 6,973 8,167 8,927 9,778

Divergence 11.1% 16.8% 14.3% 16.2%

Civil Aero Non-R&D Costs

BAML Non-R&D Costs 4,983 5,531 6,134 6,567 BAML: 80% of OE a nd 50% of service costs are variable

Projected Non-R&D Cash Costs 5,560 6,567 7,120 7,765

BAML Non-R&D EBITDA 1,296 1,462 1,677 1,846Projected Non-R&D EBITDA 1,413 1,601 1,808 2,013

Divergence 9.0% 9.5% 7.8% 9.0%

BAML Gross Margin % 20.6% 20.9% 21.5% 21.9%

Projected Gross Margin % 20.3% 19.6% 20.3% 20.6%

Civil Aero Other

Projected IAE Earnout 185 185 185 185

BAML IAE Earnout 261 245 243 222 BAML projects out IAE growth in the earnout

Consolidated

BAML Revenues 15,181 16,113 17,110 17,899

Projected Revenues 15,720 17,089 18,027 19,060

Divergence 3.5% 6.1% 5.4% 6.5% Difference almost entirely attributable to Service revenuesBAML EBITDA (After removal of 50% of Energy Holdings, prefer t 2,253 2,488 2,695 2,893

Projected EBITDA 2,309 2,490 2,702 2,912

Divergence 2.5% 0.1% 0.3% 0.6%

Projected EBITDA, using BAML's IAE 2,386 2,550 2,761 2,948

Divergence 5.9% 2.5% 2.5% 1.9%

Cash Flow

BAML UFCF 780 1,139 1,504 1,450

Projected UFCF 978 1,093 1,348 1,464

Divergence 25.3% -4.1% -10.4% 0.9%

BAML lags Trent installed base by 7 years for spares. For

service revenues, just escalates by 7%.

Difference driven by civil service, but BAML projects some

growth in other segments as well. I would be ahead

substantially if I had used their other segments' projections.


55/69

View vs. Citi

55

View vs. Citi


2013E 2014E 2015E 2016E 2017E

Civil Aero Revenues

Citi OE 3,270 3,760 4,140 4,550 5,010

Projected OE 3,181 3,967 4,272 4,609 4,920

Divergence -2.7% 5.5% 3.2% 1.3% -1.8%

Citi Service 3,560 3,830 4,120 4,430 4,760

Projected Service 3,792 4,200 4,656 5,168 5,735

Divergence 6.5% 9.7% 13.0% 16.7% 20.5% Citi projects by assuming 7.5% growth

Citi Civil Aero Total 6,830 7,590 8,260 8,980 9,770

Projected Civil Aero Total 6,973 8,167 8,927 9,778 10,656

Divergence 2.1% 7.6% 8.1% 8.9% 9.1%

Civil Aero Income

Citi assumes 5% incremental margin from OE sales and 35% incremental margin from service sales

Projected IAE Earnout 185 185 185 185 185

Citi IAE Earnout 140 115 90 65 40

Citi Civil Aero Operating Income 860 1,010 1,170 1,340 1,530

Projected Civil Aero Operating Income 918 1,017 1,169 1,313 1,478

Divergence 6.7% 0.7% -0.1% -2.0% -3.4%

ConsolidatedCiti Revenues 15,430 16,620 17,770 19,010 20,360

Projected Revenues 15,720 17,089 18,027 19,060 20,123

Divergence 1.9% 2.8% 1.4% 0.3% -1.2%

Citi EBITDA (After removal of 50% of Energy Holdings, prefer to 2,255 2,502 2,764 3,059 3,379

Projected EBITDA 2,309 2,490 2,702 2,912 3,143

Divergence 2.4% -0.5% -2.2% -4.8% -7.0%

Citi projects robust margin improvement in other

segments

Divergence in Civil Aero of fset by Citi's projected

growth in other segments

Citi assumes 34, 76, 83, 90, and 98 income from

"other"


56/69

View vs. UBS

56

View vs. UBS


2013E 2014E 2015E 2016E 2017E

Civil Aero Revenues

Broker OE 3,073 3,341 3,573 3,812 4,021 I'm ahead by 475 deliveries by 2017 -- most of street

Projected OE 3,181 3,967 4,272 4,609 4,920 agrees with me

Divergence 3.5% 18.7% 19.6% 20.9% 22.4%

Broker Service 3,883 4,187 4,530 4,907 5,320 UBS assumes 3% from pricing (2% for me)

Projected Service 3,792 4,200 4,656 5,168 5,735 UBS assumes 4.5% uptake from RPK growth (I don't)

Divergence -2.3% 0.3% 2.8% 5.3% 7.8% UBS ties service revenues to installed base (same)

Broker Civil Aero Total 6,956 7,528 8,103 8,719 9,340

Projected Civil Aero Total 6,973 8,167 8,927 9,778 10,656

Divergence 0.2% 8.5% 10.2% 12.1% 14.1%

Civil Aero Income

UBS simply assumes 5% incremental margin from OE sales and 25% incremental margin from service sales

Projected IAE Earnout 185 185 185 185 185

Broker IAE Earnout 187 195 204 213 213

Broker Civil Aero EBITA (Pre-R&D) 1,357 1,421 1,452 1,504 1,653 UBS assumes an add-back of 356M from TCA debtors

Projected Civil Aero EBITA (Pre-R&D) 1,240 1,367 1,536 1,697 1,879 per year; my front year TCA debtors is 175 and rises

Divergence -8.6% -3.8% 5.7% 12.9% 13.6% to 321 by terminal year. Operating leverage drives

the rest of the difference.

Consolidated

Broker Revenues 15,788 16,533 17,341 18,220 19,129 I get ahead on Civil Aero, offset somewhat by UBS's

Projected Revenues 15,720 17,089 18,027 19,060 20,123 projected 5% growth in rest of business. UBS has a

Divergence -0.4% 3.4% 4.0% 4.6% 5.2% (150M) flat adjustment in all years.

Broker EBITDA (After removal of 50% of Energy Holdings, prefer 2,346 2,432 2,482 2,537 2,720 Difference largely driven by Civil Aero and the fact

Projected EBITDA 2,309 2,490 2,702 2,912 3,143 that UBS apparently double counts R&D -- bakes all

Divergence -1.6% 2.4% 8.9% 14.7% 15.6% into Civil Aero but doesn't back out from other segs.

Cash Flow

BAML UFCF 515 720 732 777 882 Difference driven by EBITDA, UBS growing TCA assets

Projected UFCF 978 1,093 1,348 1,464 straight at 356M/yr (I have half that in front year), and

Divergence 89.8% 51.7% 84.1% 88.3% huge capex ahistorical capex.


57/69

Long-term time horizon drives variant view

57

Significant change in business just beyond Streets time horizon

Operating leverage takes off as installed base ramps from A350

deliveries starting in 2014

Long-term margin expansion opportunity far beyond Streets

time horizon

Quantified fixed cost percentage (40%) leads close to GE-level

economics (21% Civil Aero EBITDA margin) by 2022

Applying forward year EBITDA multiples for valuation

purposes misrepresents value for companies with product

cycles of over 30 years


58/69

Variant view against other brokers

58

View vs. Street


2013E 2014E 2015E 2016E

Civil Aero Revenues

DB Estimate 6,437 7,233 7,873

Jefferies Estimate 6,611 7,135 7,687 8,361

RBC Estimate 6,952 7,786 8,721

Projected 6,973 8,167 8,927 9,778

Divergence from Average 4.6% 10.6% 10.3% 16.9%

Civil Aero Underlying Income

JPM Estimate 876 1,007 1,142 1,273

Jefferies Estimate 850 925 1,050 1,200

DB Estimate 909 1,031 1,168

Projected 918 1,017 1,169 1,313

Divergence from Average 4.5% 3.0% 4.4% 6.2%

EPS

Bloomberg Consensus 65.6 71.9 77.2 83.4

Projected 68.1 73.9 81.6 89.1

Divergence 3.8% 2.8% 5.7% 6.8%


59/69

Management compensation (2011)

59

3M base salaries to 6 named executives

Bonuses 30%-135% of base salary based on performance

Performance measured by underlying cash flow and profit

90% of maximum achieved in 2011 = ~100% of salary awarded

40% deferred into shares for two years

Share based compensation subject to 3 year performance, and

varies between 100180% of base salary Performance measures: EPS growth, cash flow, return vs. FTSE 100

CEO must retain 200% of salary in shares; other directors 150%


60/69

Defense industry overview

60

Industry structure and characteristics essentially identical to

civil aero engines

Unlike civil aero, OE business should be profitable

Service revenues much lumpier due to nature of conflict, but

LTSA penetration (25%) is growing

Procurement more politically driven than in civil

Governments play a role in funding R&D (net vs. gross R&D)

Information very difficult to come by, given political and

security concerns


61/69

Defense portfolio

61

Type Engine RR Stake

~Unfilled

Orders

Transport TP400 28%

>174

Core

Combat

Lift-

system 100% >340

Combat EJ200 34% 140

Helis RTM322 50% ~150

Transport AE1107C 100% 98

Transport AE2100 100% ~40

Helis MTR390 50% ~70

Transport AE3007 100% Few

Combat F136 40% 0

Combat Adour 50% 0

Combat Adour 50% ~0

Combat Adour 50% 0

Combat Pegasus 100% 0

Combat RB199 100% 0

Trainers Adour 50% 0Trainers FJ44 50% 0

Transport T56 100% 0



Helis RTM322 50%

Helis RTM322 50% 0

Helis CTS800 50% Few

Helis Gem 100% 0

Helis Gnome 0

Eurofighter Typhoon

Status

Production rate cut by almost 50% in 2012; currently in Tranche 3 orders

Platform

A400M

7.6B EUR program, created by treaty -- any more cuts from core countries (France/Germany) below 170

orders will threaten the program. Cuts appear to have already happened

F35-B JSF STOVL Variant

Massive fighter program, with enormous potential (>2k JSFs in US alone), but equally scary cost/cost

overruns. Highly susceptible to cuts; under pressure already. STOVLs are perhaps 10-20% of orders.

Out of production

F35

In JV with GE to produce an alternative to P&W's F135. Funding pulled by Congress in 2011; GE and RR are

continuing to fund some R&D since they believe funding will return, just at a lower level.

NHI NH90 Stressed program due to order cutbacks and late deliveries.

SEPECAT Jaguar Retired in 2005/07 by France/UK; India upgrading fleet but RR decided not to tender

BAE Hawk New orders primarily used as trainers

Mitsubishi F-1

T-45 Goshawk Out of productionSaab SK60 Out of production

V22 Osprey Cut from 122 in early 2012

C130 J Hercules / C-27 ~900 engines delivered. Producing at about 24/year, with rate going down

Global Hawk Very expensive program that might be mothballed.

Eurocopter Tiger

Joint ~7.3B German/French program; some cuts have gone down in 2012, but Eurocopter doesn't expect

more cuts.

Harrier

Out of production

Tornado Out of production

C130 A-H Hercules Out of production

P-3C Orion Out of production

E-2C Hawkeye Out of production

Black Hawk

Lynx Superceded by Super Lynx

Augusta Westland Sea King Out of production, to be replaced by models such as NH 90.

Apache WAH-64D, which RR's engines are on, don't appear to be currently on order.

Super Lynx 300 Seems to be only small export production now (Algeria recently ordered 6).

Note: I am not a defense analyst, so I guarantee that there will be errors in

the following. Use only for a broad overview!


62/69

Defense outlook

62

Rolls Royce is a leader in transport end market

Management notes that transport flying hours have been resilient

over past 5 years despite conflict wind-downs

Management guides to a 450B market opportunity over next

20 years

UK Strategic Defense Review already in the past; pressure

likely to stem from US/EU, while export markets continue to

be an opportunity


63/69

Marine segment overview

63

Key businesses:

Ship design and OEDesigns ships and serves as OEM. Per

Company, RR can provide goods and services worth 60% of the

value of a ship: essentially everything except for steel and labor

Aero engine derivativesProvides engines for various uses

LTSA covers 5% of services, clear opportunity for expansion

Key end markets:

Offshore (47%)Primarily offshore oil and gas services. Should

grow quickly as deepwater grows MerchantSpecialist ships (e.g. cargo, tugs, yachts, etc.)

NavalServe as OEM to a range of naval applications


64/69

Energy segment overview

64

Oil & Gas (64% of revenues)drives most of segment profit

Provides aero-derivatives and centrifugal compressors for pumping bothon and offshore

Civil nuclear (11%)

Instrumentation and control (I&C) in 200 reactors worldwide

Contracts to supply I&C to 70% of reactors in China

Other capabilitiesSystems and component engineering; reactorsupport; safety, licensing, and environmental engineering

Power generation (25%)aero derivatives and services

25% of service revenues covered by LTSAs


65/69

Energy Holding segment overview

65

50/50 JV with Daimler, but RR will control the entity

Daimler has the right to put its stake to RR until end of 2018

Previously equity accounted, but will be consolidated in 2013

BergenSupplies diesel and gas engines to marine segment

and to external power generation customers

TognumAcquired in 2011 for 1.5B GBP from RR. Produces

engines, power generation systems, and components for ships,

heavy land, rail, defense, oil & gas end markets

Integration opportunities with marine and energy segments

296M of preliminary 2012 EBIT


66/69

Drivers of civil aero market growth

66

Data from Boeing and Airbus market outlooks 2012-2031

Airplane demand driven by APAC

Potential for 10k planes worth $1.6T per Airbus

Potential for 12k planes worth $1.7T per Boeing (see below)

Demand by region

Future market value and airplane deliveries 2012 to 2031

Region $B Airplanes

Asia Pacific 1,700 12,030

Europe 970 7,760

North America 820 7,290Middle East 470 2,370

Latin America 260 2,510

C.I.S. 130 1,140

Africa 120 900

Total 4,470 34,000


67/69

Drivers of civil aero market growth (cont.)

67Source: Airbus market outlook, 2012-31

Pension assumptions slightly aggressive,


68/69

e s o assu pt o s s g t y agg ess e,

but underfund is small relative to EV

68Source: 2012 FY press release, and 2011 Annual Report


69/69

C share structure

Dividends are paid in C shares, essentially a non-cumulative

non-voting redeemable preferreds that can be redeemed forcash or reinvested in ordinary shares at nominal value of 0.1

pence per C share

C shares retained by owners get a dividend of 75% of LIBORon the nominal value of each share (a poor use of capital)

As of the end of 2011, there were 6.4B C shares in issue,

which corresponds to approx. 6.4M of essentially free float for

Rolls Royce

bgf chisong rollsroyce

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