* see note 4
** see note 3
Sir John Rose, Chief Executive, said:
“We are pleased to have increased our order book, sales and underlying earnings in a challenging environment. These results strongly endorse the Group’s strategy and demonstrate the resilience and organic growth capabilities of our business model.
“For 2007, we are confident that the measures we are taking to improve productivity, coupled with the underlying growth of the Group and the robust business model, will enable us to continue to grow underlying revenues and profits and generate a positive cash flow.”
The Group continued to make strong progress in 2006, increasing sales to £7,156 million (2005 £6,603 million), with underlying sales growth of 14 per cent, and increasing underlying profit before tax by 19 per cent to £705 million (2005 £593 million). Importantly, our ability to access growing markets on a global basis enabled us to continue to grow our order book, which ended the year at £26.1 billion (2005 £24.4 billion).
We continue to invest in technologies, products, people and capabilities with the objective of broadening and strengthening our product portfolio, improving our efficiency and enhancing the environmental performance of our products. In 2006, total investment in research and development amounted to £747m (2005 £663m).
Rolls-Royce is continuing to play a proactive and positive role on environmental issues and we have a strong track record of performance in this area. Our focus remains on reducing the environmental impact of our products and operations and on working towards a more sustainable future through the development of new low-carbon technologies.
After increasing investment in manufacturing capability and research and development, there was a strong cash inflow of £491 million resulting in an improvement of £410 million in our average cash balance and a cash balance of £826 million at the end of the year. Basic earnings per share rose to 57.32p (2005 20.11p) with underlying earnings per share increasing by 22 per cent to 29.81p (2005 24.48p). We propose to increase the final payment to shareholders to 5.92p making a total payment for the year of 9.59p per share, an increase of ten per cent on 2005.
Our overall performance in 2006 was strong in an undoubtedly challenging year. The underlying financial results were achieved after accommodating a further seven cent deterioration in the dollar achieved rate relative to 2005. We expect to absorb a similar further deterioration in the exchange rate we achieve in 2007.
We manage our exposure to the US dollar by long-term hedging. Today we have the benefit of a hedge book of approximately US$10 billion, which means that we have clear visibility of the exchange rate we can achieve over the next three years. Whilst it is impossible to offset sustained dollar weakness through hedging, the cover we have taken reduces the volatility that exchange rate fluctuations cause and creates the opportunity for us to take other mitigating actions, such as cost reduction and the ‘dollarisation’ of our cost base.
Raw material price inflation has been a significant factor for all manufacturing industry. It is helpful that, as a high value-added business, the cost of raw materials forms a relatively small proportion of our total costs. We have maintained our focus on productivity and efficiency measures and where appropriate we hedge our exposure in the financial commodities markets. The nature of the business also enables us to enter into long-term procurement contracts, which help protect us from future fluctuations in raw material prices and give us visibility of our cost base.
We are continuing to invest globally in new facilities and to improve the performance of our international supply chain. These changes, which are occurring at the same time as a significant increase in load, have been managed well in tough conditions.
We are continuing our discussions with the relevant parties about our UK pension funds. Our proposals include a cash injection of £500m. Our overall intent is to make a significant step towards reducing deficits and limiting the impact on the business of volatility in interest rates and share prices. We expect to make progress in 2007.
We operate in a competitive and challenging environment and in doing so, we benefit from a consistent strategy, a strong order book, long programme life cycles and the revenue generated by the provision of value-added services to the users of our products. Consequently we have good visibility of our future workload and market opportunity. The results in 2006 demonstrate the resilience of the Group and its business model.
Each of our businesses offers significant opportunities for organic growth. Over the next 20 years, we estimate the global accessible market to be worth some two trillion US dollars, of which about half will relate to the provision of aftermarket services.
The Group ended 2006 with a net cash balance of £826 million. In 2007, a substantial portion of this balance is earmarked to address the pension deficit. We believe that a strong balance sheet is essential for a long-term business such as ours. We compete against large competitors across programmes where returns are measured over decades, where we enter into long-term service commitments and where significant investments to gain market access are the norm. During 2007, we will be reviewing our financial strategy in the light of the Group’s continuing cash generation, investment needs, progress on resolving the pension deficit and underlying performance.
For 2007, we are confident that the measures we are taking to improve productivity, coupled with the underlying growth of the Group and the robust business model, will enable us to continue to grow underlying revenues and profits and generate a positive cash flow.