Rolls Royce Buy Recommendation LSE: RR.

Chi Song 3/16/2013

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

Introduction to Rolls Royce

Closest to pure play aero engine/aero engine derivative maker Supplies 4 end markets, with the most important being civil and defense aerospace
BUSINESS BREAKDOWN, 2012 FY
Underlying Revenue Underlying Pretax Profit

52%

51%

28%

20%

18%

21%

8%

1%

2%

8%

CIVIL

DEFENSE

MARINE

ENERGY

-9%

ENERGY HOLDING

CORP/OTHER

-1%

Buy recommendation: investment thesis

1. Aero engines is an oligopoly with high barriers to entry 2. Poised to overtake GE as the worlds largest supplier of widebody 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, defensive industry, 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). ~12 15% IRR with lower than equity risk for 3 10 years.
5

Current capitalization and valuation

Trades in London at 10.85 GBP/share Trades at ~4.4% LTM UFCF yield on EV, including growth CapEx
xEBITDA LTM 2017E 0.7x 0.4x 1.3x 0.8x 2022E 0.3x 0.5x FCF Yield % LTM 2017E 2022E

CAPITAL STRUCTURE Security Cap Stack Debt 1,383.0 Pension + RRSP 1,106.0 Total Debt 2,489.0 (-) Excess Cash 2,585.0 Net Debt (96.0) Common Equity 20,306.9 Enterprise Value 20,210.9 LTM 1,977 889 2017E 3,143 1,876 7,931

0.0x 0.0x 0.0x Without incorporating cash build: 10.2x 6.4x 4.4x 2022E 4,574 2,885 19,965

4.4%

9.3%

14.3%

EBITDA UFCF (Incl. all CapEx) Cash Build

Share Data Px/Sh. 10.9 S/O (M) 1,871.6

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.

Numbers from 2/22/2013 Not materially different today

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

Thesis focuses on Civil segment

BUSINESS BREAKDOWN, 2012 FY
Underlying Revenue Underlying Pretax Profit

52%

51%

28%

20%

18%

21%

8%

-1%

CIVIL

DEFENSE

MARINE

ENERGY

1%

ENERGY HOLDING

2%

8%
CORP/OTHER

-9%

Civil aero engine industry

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:

Widebody Commercial Airbus/Boeing dual aisle frames (e.g. B787) Narrowbody Commercial single aisle frames, mainly Airbus/Boeing Regional/Corporate Smaller airframes, includes Embraer, Bombardier, and Gulfstream

Aero engine industry structure is heavily consolidated, with three major players

GE Aviation Industry leader

$19B 2011 revenues $3.5B 2011 operating income

Pratt & Whitney UTX subsidiary

$13.4B 2011 revenues $2B 2011 operating income

12.2B GBP 2012 revenues 1.4B GBP 2012 operating income All three have hundred-year histories

Rolls Royce

Oligopoly structure since 1970s

10

Other aero engine industry competitors are JVs of 3 majors due to high barriers to entry

CFM 50/50 JV between GE and Snecma of SAFRAN Group

75% share in unfilled narrowbody orders

Engine Alliance 50/50 JV between GE and P&W, founded in 2001 to produce the GP7200 for the A380 program

International Aero Engines Initially 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

11

Airframe and engine OEM relationships: The A350 story

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 to incentivize 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

12

Business models in the aerospace industry tend to focus on aftermarket

Engines are highly engineered, long-lived assets (useful lives over 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%

Implication Installed base drives profitability

13

Services drive most of Rolls Royces revenue base and a larger share of income

14

The Rolls Royce model: TotalCare (LTSA)

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)

15

Graphic source: RR 2012 FY presentation

LTSAs value proposition

To customers:

Predictable costs failure risks transferred to OEM Flexible contract design Better matching of load and capacity Manage time and type of maintenance for customers benefit Optimized systems on-wing engine monitoring by OEM allows for rapid response and maximized uptime

To Rolls Royce:

16

Opportunity for margin expansion from learning curve Aligns failure risk to OEM Optimizes shop loading RR manages maintenance schedules

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

17

The aero engine business has the indicators of high barriers to entry

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%

Fiscal Year Ending Dec. 31st, 2008 2009 2010 10.5% N/A 21.0% 9.2% 19.3% 19.0% 8.8% 15.6% 19.6%

Barriers to Entry Key Stats 2007 Aero Engine Segment ROA Rolls Royce GE Aviation Pratt & Whitney Aero Engine Segment EBITDA Margins Rolls Royce GE Aviation Pratt & Whitney 10.9% N/A 21.1% 2011 7.4% 14.9% 17.5% 2012 8.8% 14.9% 10.6%

13.7% N/A 21.1%

13.6% N/A 21.0%

13.0% 23.8% 19.0%

13.3% 22.0% 19.6%

14.7% 21.6% 17.5%

16.4% 22.0% 10.6%

18

Aero engine industry features nearly insurmountable barriers to entry

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

19

Key barrier to entry: Entrants require billions of capital with the capacity to suffer

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 at breakeven or a loss

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

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

Most engines are delivered on 5 years warranty Breakeven point up to two decades after R&D program launch

20

Key barrier to entry: Economies of scale

R&D Large R&D budgets required to maintain technological competitiveness; easier to amortize over large revenue base

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

Service facilities Aero engines require a worldwide maintenance facility presence

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

Employees Compensation is ~30% of RRs cost base

21

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

22

RR poised to take leadership in widebody engines, driven by A350 exclusivity

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
Produc- In Prodtion Yrs. uction? 2011 2013 2004 1992 2007 1982 1970 1993 1993 2011 1982 2007 1974 2007 Yes Yes Yes Yes Yes Yes Yes Yes No No No # of Engines 4 2 2 2 4 2 4 2 4 2 2 # of Seats 290 - 330 250 - 300 386 - 550 335 525 - 853 190 - 210 366 - 660 314 - 550 375 - 440 218 - 280 226 Operating* 49 0 445 931 97 1041 1458 621 362 166 312 Unfilled Orders 792 592 353 307 165 67 67 12 0 0 0 Total Orders 841 592 798 1244 262 1108 1525 633 377 255 561 Boeing Airbus Boeing Airbus Airbus Boeing Boeing Boeing Airbus Airbus Airbus 787 A350 777F and 300ER A330 A380 767 747 777200/300 A340 A310 A300 Engine 1 Engine 1 Engine 2 Engine 2 Engine 3 Engine 3 Engine 1 Provider Share Engine 2 Provider Share Engine 3 Provider Share Trent Rolls GEnx GE 59% 1000 Royce 41% N/A N/A N/A Trent Rolls XWB Royce 100% N/A N/A N/A N/A N/A N/A GE90 Trent 700 GP 7200 JT9D GE 100% N/A N/A N/A N/A N/A Rolls Pratt & Royce 57% PW4000 Whitney 21% CF6 GE Engine Rolls Alliance 56% Trent 900 Royce 44% N/A N/A Pratt & Whitney N/A CF6 GE N/A N/A N/A Various GE and Pratt & Whitney engines N/A N/A Rolls Pratt & GE 60% Trent 800 Royce 40% PW4000 Whitney Rolls 100% ('02- CFM 56100% ('92Royce '11) 5C CFM '02) N/A N/A Pratt & Whitney N/A CF6 GE N/A N/A N/A Pratt & Whitney N/A CF6 GE N/A N/A N/A N/A 22% N/A N/A N/A N/A N/A N/A N/A

Category Wide Wide Wide Wide Wide Wide Wide Wide Wide Wide Wide

Manufacturer Model

GE90 Trent 500 PW4000 PW4000

23

Civil OE revenues will CAGR at 7% for next 10 years as production ramps

Civil Aero OE Revenues Build 2012 108 65% 140 5.9 832 30 53% 64 8.6 549 46 21% 38 5.9 226 2013E 120 57% 137 6.1 829 35 44% 62 8.8 539 65 41% 107 6.1 646 2014E 132 57% 150 6.2 930 35 44% 62 8.9 550 120 41% 197 6.2 1,216 10 100% 20 5.8 116 630 2.1 1,293 2,934 (35)
-1.2%

A330 Production RR Share of A330 Trent 700 (A330) Deliveries Est. Cost per Engine (72k k-lbs. Thrust) Trent 700 Revenues A380 Production RR Share of A380 Trent 900 (A380) Deliveries Est. Cost per Engine (85k k-lbs. Thrust) Trent 900 Revenues B787 Production RR Share of B787 Trent 1000 (B787) Deliveries Est. Cost per Engine (70k k-lbs. Thrust) Trent 1000 Revenues A350 Production RR Share of A350 Trent XWB (A350) Deliveries Est. Cost per Engine (86k k-lbs. Thrust) Trent XWB Revenues Other Engine Deliveries Est. Cost per Engine Total Other OE Revenues Civil Aero OE Underlying Revenues Less: Gross Additions to Recoverable Engine Costs
As % of Civil Aero OE Underlying Revenues

Fiscal Year Ending Dec. 31st, 2015E 2016E 2017E 2018E 132 132 120 108 57% 57% 57% 57% 150 150 137 123 6.3 6.4 6.6 6.7 949 968 897 824 35 44% 62 9.1 561 120 41% 197 6.3 1,241 30 100% 60 5.9 353 630 2.2 1,372 4,475 (203)
-4.5%

2019E 96 57% 109 6.8 747 30 44% 53 9.9 520 120 41% 197 6.8 1,343 120 100% 240 6.4 1,530 630 2.4 1,485 5,625 (256)
-4.5%

2020E 96 57% 109 7.0 762 25 44% 44 10.1 442 120 41% 197 7.0 1,370 132 100% 264 6.5 1,717 630 2.4 1,514 5,805 (264)
-4.5%

2021E 96 57% 109 7.1 777 25 44% 44 10.3 451 120 41% 197 7.1 1,397 132 100% 264 6.6 1,751 630 2.5 1,545 5,921 (269)
-4.5%

2022E 96 57% 109 7.2 792 25 44% 44 10.5 460 120 41% 197 7.2 1,425 132 100% 264 6.8 1,786 630 2.5 1,576 6,040 (275)
-4.5%

35 44% 62 9.3 572 120 41% 197 6.4 1,265 52 100% 104 6.0 625 630 2.2 1,399 4,829 (220)
-4.5%

35 44% 62 9.5 584 120 41% 197 6.6 1,291 78 100% 156 6.1 956 630 2.3 1,427 5,154 (234)
-4.5%

35 44% 62 9.7 595 120 41% 197 6.7 1,316 102 100% 204 6.3 1,275 630 2.3 1,456 5,466 (249)
-4.5%

630 2.1 1,318 3,332 (152)

-4.5%

630 2.1 1,345 4,156 (189)

-4.5%

Civil Aero OE Underlying Revenues, Net of Loss at OE

Growth, YoY CAGR from 2012

2,899
38.2%

3,181
9.7% 9.7%

3,967
24.7% 17.0%

4,272
7.7% 13.8%

4,609
7.9% 12.3%

4,920
6.7% 11.2%

5,218
6.0% 10.3%

5,369
2.9% 9.2%

5,541
3.2% 8.4%

5,652
2.0% 7.7%

5,765
2.0% 7.1%

24

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

Service revenues CAGR at 10% for next 10 years as Trent installed base CAGRs at 13%

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
2012 2,212 2013E 2,507
10 13.3% 13.3%

Civil Aero Services Revenues Build 2014E 2,926

10 16.7% 15.0%

Trent Installed Base

2015E 3,385
10 15.7% 15.2%

Fiscal Year Ending Dec. 31st, 2016E 2017E 2018E 3,888 4,429 5,004
10 14.9% 15.1% 10 13.9% 14.9% 10 13.0% 14.6%

2019E 5,593
10 11.8% 14.2%

2020E 6,198
10 10.8% 13.7%

2021E 6,802
10 9.7% 13.3%

2022E 7,406
10 8.9% 12.8%

Trent Base Attrition, Units/Yr (Primarily Trent 800 Retirements) 10 Trent Base Growth 11.7% CAGR from 2012

Revenue per Installed Engine Trent Service Revenues

Trent as % of Civil Aero Service Revenues

0.87 1,927
55%

0.89 2,227
59%

0.91 2,651
63%

0.92 3,129
67%

0.94 3,665
71%

0.96 4,259
74%

0.98 4,909
77%

1.00 5,596
80%

1.02 6,325
82%

1.04 7,080
84%

1.06 7,863
85%

RB211 Installed Base

RB211 Net Growth

1,839
-5%

1,729
-6%

1,608
-7%

1,479
-8%

1,346
-9%

1,211
-10%

1,078
-11%

949
-12%

825
-13%

710
-14%

603
-15%

Revenue per Installed Engine RB211 Service Revenues

RB211 as % of Civil Aero Service Revenues

0.38 701
20%

0.39 672
18%

0.40 637
15%

0.40 598
13%

0.41 555
11%

0.42 510
9%

0.43 463
7%

0.44 415
6%

0.45 368
5%

0.46 323
4%

0.46 280
3%

Corporate and Regional Installed Base

Corporate and Regional Net Growth

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

8,449
0%

Revenue per Installed Engine Corporate and Regional Service Revenues

Corp. and Regional as % of Civil Aero Service Revenues

0.10 876
25%

0.11 893
24%

0.11 911
22%

0.11 929
20%

0.11 948
18%

0.11 967
17%

0.12 986
16%

0.12 1,006
14%

0.12 1,026
13%

0.12 1,047
12%

0.13 1,068
12%

Civil Aero Service Revenues

Growth, YoY CAGR from 2012

3,503
4.9%

3,792
8.3% 8.3%

4,200
10.7% 9.5%

4,656
10.9% 9.9%

5,168
11.0% 10.2%

5,735
11.0% 10.4%

6,357
10.8% 10.4%

7,017
10.4% 10.4%

7,719
10.0% 10.4%

8,450
9.5% 10.3%

9,211
9.0% 10.2%

25

Note: All projections include a 2% global inflation adjustment

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

26

Segment margins have room to improve

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

Margin recognition improves as LTSA contracts mature

2007 2008 13.6% N/A 21.0% 2009 13.0% 23.8% 19.0% 2010 13.3% 22.0% 19.6% 2011 14.7% 21.6% 17.5% 2012 16.4% 22.0% 10.6%

Aero Engine Segment EBITDA Margins Rolls Royce GE Aviation Pratt & Whitney

13.7% N/A 21.1%

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

27

Differences between RR margins and GE margins driven by scale and operations

RR management notes that the margin differential between RR and GE is largely driven by scale and supply chain Scale Lower unit volume in a high fixed cost business (esp. maintenance) drives lower margins

Supply chain RR 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

28

Aero engines is a high operating leverage business with extensive fixed costs

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 to support Trent
43 370
37,300 197,131

Cost Structure Decomposition Corporate Segment Net R&D

Employees Group Revenue per Employee

32 381
38,600 202,513

39 403
39,000 234,538

68 379
39,000 259,179

55 422
38,500 282,234

49 463
38,900 289,897

61 589
40,400 302,203

Employment Costs Total Group Identfiable Non-Pure Variable Costs

As % of Group Costs

1,795 2,208
34.4%

1,990 2,403
35.4%

2,087 2,529
31.8%

2,087 2,534
28.5%

2,213 2,690
28.2%

2,330 2,842
29.3%

2,364 3,014
29.3%

Total Group Underlying Costs Excl. D&A

6,416

6,784

7,952

8,878

9,544

9,710

10,293

29

Service revenue growth and operating leverage drive 12% EBITDA CAGR to 2022

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
Fiscal Year Ending Dec. 31st, 2016E 2017E 2018E 4,609 4,920 5,218 5,168 5,735 6,357
52.9% 53.8% 54.9%

Civil Aero EBITDA Build 2012 2,899 3,503

54.7%

Civil Aero OE Revenues, Incl. Capitalized Loss Civil Aero Service Revenues
Civil Aero Service as % of Total Civil Aero Revenues

2013E 3,181 3,792

54.4%

2014E 3,967 4,200

51.4%

2015E 4,272 4,656

52.2%

2019E 5,369 7,017

56.7%

2020E 5,541 7,719

58.2%

2021E 5,652 8,450

59.9%

2022E 5,765 9,211

61.5%

Total Civil Aero Revenues

Growth, YoY Revenue CAGR from 2012

6,402
17.7%

6,973
8.9% 8.9%

8,167
17.1% 12.9%

8,927
9.3% 11.7%

9,778
9.5% 11.2%

10,656
9.0% 10.7%

11,575
8.6% 10.4%

12,387
7.0% 9.9%

13,260
7.1% 9.5%

14,102
6.3% 9.2%

14,976
6.2% 8.9%

Civil Aero OE EBITDA, Incl. Capitalized Loss Civil Aero IAE Earnout Civil Aero Service EBITDA
Civil Aero Service EBITDA Margin %

92 963
27.5%

185 1,090
28.7%

185 1,250
29.8%

185 1,441
31.0%

185 1,629
31.5%

185 1,839
32.1%

185 2,070
32.6%

185 2,319
33.1%

185 2,585
33.5%

185 2,863
33.9%

185 3,153
34.2%

Civil Aero EBITDA

Underlying EBITDA Margin %, Excl. Earnout EBITDA CAGR from 2012

1,055
15.0%

1,275
15.6% 20.8%

1,435
15.3% 16.6%

1,626
16.1% 15.5%

1,814
16.7% 14.5%

2,024
17.3% 13.9%

2,255
17.9% 13.5%

2,504
18.7% 13.1%

2,770
19.5% 12.8%

3,048
20.3% 12.5%

3,338
21.1% 12.2%

30

Growth in Civil Aero segment alone would drive 9% EBITDA CAGR to 2022
Consolidated EBITDA Build 2012 OE Revenues Civil Aero, Net of Loss at OE Defense Marine Energy Consolidated OE Revenues
OE Revenues as % of Total

2013E 3,181 1,256 1,314 351 6,101

48.0%

2014E 3,967 1,281 1,340 358 6,946

49.5%

2015E 4,272 1,306 1,367 365 7,310

49.1%

Fiscal Year Ending Dec. 31st, 2016E 2017E 2018E 4,609 1,332 1,394 372 7,708
48.6%

2019E 5,369 1,414 1,480 395 8,658

45.9%

2020E 5,541 1,442 1,509 403 8,896

44.8%

2021E 5,652 1,471 1,539 411 9,073

43.6%

2022E 5,765 1,501 1,570 419 9,255

42.4%

2,899 1,231 1,288 344 5,762

47.9%

4,920 1,359 1,422 380 8,081

47.9%

5,218 1,386 1,450 387 8,442

47.1%

Service Revenues Civil Aero Defense Marine Energy Consolidated Service Revenues
OE Revenues as % of Total

3,503 1,186 961 618 6,268

52.1%

3,792 1,210 980 630 6,613

52.0%

4,200 1,234 1,000 643 7,076

50.5%

4,656 1,259 1,020 656 7,590

50.9%

5,168 1,284 1,040 669 8,161

51.4%

5,735 1,309 1,061 682 8,788

52.1%

6,357 1,336 1,082 696 9,471

52.9%

7,017 1,362 1,104 710 10,193

54.1%

7,719 1,390 1,126 724 10,959

55.2%

8,450 1,417 1,148 739 11,754

56.4%

9,211 1,446 1,171 753 12,582

57.6%

Energy Holdings Revenues Consolidated Revenues

Revenue Growth

12,030
9.1%

3,006 15,720
30.7%

3,066 17,089
8.7%

3,127 18,027
5.5%

3,190 19,060
5.7%

3,254 20,123
5.6%

3,319 21,232
5.5%

3,385 22,237
4.7%

3,453 23,307
4.8%

3,522 24,350
4.5%

3,592 25,429
4.4%

EBITDA Margins
Civil Aero Defense Marine Energy 16.5% 19.1% 15.8% 6.5% 18.3% 19.1% 15.8% 6.5% 17.6% 19.1% 15.8% 6.5% 18.2% 19.1% 15.8% 6.5% 18.6% 19.1% 15.8% 6.5% 19.0% 19.1% 15.8% 6.5% 19.5% 19.1% 15.8% 6.5% 20.2% 19.1% 15.8% 6.5% 20.9% 19.1% 15.8% 6.5% 21.6% 19.1% 15.8% 6.5% 22.3% 19.1% 15.8% 6.5%

EBITDA Contribution Civil Aero Defense Marine Energy Energy Holding (50% Consolidated) Corporate Consolidated EBITDA
EBITDA Margin % EBITDA Growth EBITDA CAGR from 2012

1,055 460 355 63 109 (65) 1,977

16.4% 22.3%

1,275 470 362 64 205 (66) 2,309

18.2% 16.8% 16.8%

1,435 479 369 65 209 (68) 2,490

17.8% 7.8% 12.2%

1,626 489 377 66 213 (69) 2,702

18.1% 8.5% 11.0%

1,814 498 384 68 218 (70) 2,912

18.3% 7.7% 10.2%

2,024 508 392 69 222 (72) 3,143

18.6% 8.0% 9.7%

2,255 519 400 71 226 (73) 3,397

19.0% 8.1% 9.4%

2,504 529 408 72 231 (75) 3,669

19.5% 8.0% 9.2%

2,770 540 416 73 235 (76) 3,958

19.9% 7.9% 9.1%

3,048 550 424 75 240 (78) 4,260

20.5% 7.6% 8.9%

3,338 561 433 76 245 (79) 4,574

20.9% 7.4% 8.8%

31

Note: All projections include a 2% global inflation adjustment

RR generates robust free cash flow as growth ramps

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

Fiscal Year Ending Dec. 31st, 2016E 2017E 2018E 2019E 2,912 3,143 3,397 3,669
10.2% 9.7% 9.4% 9.2%

Earnings Bridge 2012 1,977 (487) (318) 1,172 (61) 14 1,125 2013E 2,309
16.8%

Consolidated Underlying EBITDA

EBITDA CAGR from 2012

2014E 2,490
12.2%

2015E 2,702
11.0%

2020E 3,958
9.1%

2021E 4,260
8.9%

2022E 4,574
8.8%

Less: D&A Less: Taxes Unlevered Underlying Earnings Less: Underlying Finance Costs Add: Interest Tax Shield Levered Underlying Earnings FCF Bridge

(593) (395) 1,321 (61) 14 1,274

(632) (427) 1,431 (61) 14 1,384

(657) (470) 1,575 (61) 14 1,528

(686) (512) 1,714 (61) 14 1,667

(715) (559) 1,870 (61) 14 1,823

(744) (610) 2,043 (61) 14 1,996

(769) (667) 2,233 (61) 14 2,186

(796) (727) 2,435 (61) 14 2,388

(821) (791) 2,648 (61) 14 2,601

(847) (857) 2,870 (61) 14 2,823

Underlying Unlevered Earnings Less: Additional Invested Capital Required

Memo: Projected CapEx & Other WC Investments Memo: Projected Increase in TCA Debtor

2012 1,172 (664)

(795) (356)

2013E 1,321 (343)

(762) (175)

2014E 1,431 (338)

(722) (248)

2015E 1,575 (226)

(612) (272)

Fiscal Year Ending Dec. 31st, 2016E 2017E 2018E 2019E 1,714 1,870 2,043 2,233 (250) (253) (260) (222)
(637) (298) (647) (321) (663) (341) (642) (349)

2020E 2,435 (236)

(674) (358)

2021E 2,648 (222)

(685) (358)

2022E 2,870 (227)

(716) (358)

Unlevered Free Cash Flow Less: Underlying Financing Costs, Net of Tax Shield Levered Free Cash Flow

508 (47) 461

978 (47) 931

1,093 (47) 1,046

1,348 (47) 1,301

1,464 (47) 1,417

1,617 (47) 1,570

1,782 (47) 1,735

2,011 (47) 1,964

2,198 (47) 2,151

2,426 (47) 2,379

2,643 (47) 2,596

32

Assumes no change in debt financing, rising asset utilization to a level still significantly below P&W/GE, and decreasing invested capital as % of assets driven by increasing LTSA float financing. Company features negative net working capital position, so working capital has been excluded from FCF calculations.

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

33

Growth story de-risked by defensible industry and extensive firm order book

Industry effectively impermeable to new entrants, ensuring business stability 60B GBP firm order book (5 years of revenues)
2006 2007 35.9 4.4 4.7 0.9 45.9 Fiscal Year Ending Dec. 31st, 2008 2009 2010 43.5 5.5 5.2 1.3 55.5 47.0 6.5 3.5 1.3 58.3 48.5 6.5 3.0 1.2 59.2 2011 51.9 6.0 2.7 1.5 62.1 2012 49.6 5.2 4.0 1.3 60.0

Backlog and Other

Backlog by Segment (Bil. GBP) Civil Aerospace Defence Aerospace Marine Energy Total Backlog Years' of Revenue in Backlog Civil Aerospace Defence Aerospace Marine Energy Consolidated Average

20.0 3.2 2.4 0.5 26.1

5.4 2.0 1.8 1.0 3.5

9.0 2.6 3.0 1.6 5.9

9.9 3.3 2.4 1.7 6.1

10.8 3.2 1.4 1.3 5.8

10.1 3.1 1.2 1.0 5.4

9.5 2.7 1.2 1.4 5.5

7.7 2.1 1.8 1.3 4.9

34

Conservative valuation assumptions leave robust margin of safety

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 2006 2011 has a 99% r-squared

35

LTSAs de-risk and annuitize cash flows, supporting lower cost of capital

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

80% 60% 40% 20% 0%

Civil aerospace sector is inherently defensive

% of Firm, 2022 FY
73% 42% 26% 13% 0% Civil Service Civil OE Underlying Revenue Defense Underlying EBITDA Other 12% 18% 15%

36

and future growth opportunities should sustain or grow multiples

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 compete for 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

37

Return profiles are robust even if exiting at LTM EBITDA multiples

~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: Accumulated LFCF Add: Exit at LTM EV/EBITDA Realized Profits Current EV Holding Period (Years) IRR

2017E Exit: 3,419 Accumulated LFCF 27,628 Add: Exit at LTM EV/EBITDA 31,046 Realized Profit 20,211 Current EV 3 Holding Period (Years) 15.4% IRR

2022E Exit: 6,265 Accumulated LFCF 32,132 Add: Exit at LTM EV/EBITDA 38,397 Realized Profits 20,211 Current EV 5 Holding Period (Years) 13.7% IRR

17,090 46,761 63,851 20,211 10 12.2%

38

DCF and sensitivity suggest target price of 16 GBP with robust margin of safety

DCF 2013E 978 2014E 1,093 2015E 1,348 Fiscal Year Ending Dec. 31st, 2016E 2017E 2018E 2019E 1,464 1,617 1,782 2,011 2020E 2,198 2021E 2,426 2022E 2,643 10.2 46,761 10% 9.8 19,506

10% discount rate very conservative for defensible business and firm orders Current share price robust to multiple compression

UFCF Exit Multiple (xEBITDA) Exit Value WACC Discount Period Discounted Cash Flows Sum of Discounted Cash Flows Less: Net Debt (Cash) Equity Value Equity Value per Share (GBP)

10% 0.8 910 28,622 (96) 28,526 15.2

10% 1.8 925

10% 2.8 1,037

10% 3.8 1,024

10% 4.8 1,028

10% 5.8 1,030

10% 6.8 1,057

10% 7.8 1,050

10% 8.8 1,054

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 8.0% 12.9 13.4 14.0 14.6 15.2 15.8 8.5% 12.4 13.0 13.5 14.1 14.6 15.2 9.0% 12.0 12.5 13.0 13.6 14.1 14.6 9.5% 11.6 12.1 12.6 13.1 13.6 14.1 10.0% 11.2 11.6 12.1 12.6 13.1 13.6 10.5% 10.8 11.2 11.7 12.2 12.6 13.1 11.0% 10.4 10.9 11.3 11.7 12.2 12.6 11.5% 10.1 10.5 10.9 11.3 11.8 12.2 12.0% 9.7 10.1 10.5 11.0 11.4 11.8

9.0x 16.3 15.7 15.1 14.6 14.1 13.6 13.1 12.6 12.2

9.5x 16.9 16.3 15.7 15.1 14.5 14.0 13.5 13.0 12.6

10.0x 17.5 16.8 16.2 15.6 15.0 14.5 14.0 13.5 13.0

39

Further sensitivity analyses suggest robust margin of safety against key assumptions
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% 8.0% 13.5 14.5 15.6 16.7 17.7 18.8 19.9 8.5% 13.0 14.0 15.0 16.0 17.1 18.1 19.1 9.0% 12.5 13.5 14.5 15.5 16.4 17.4 18.4 9.5% 12.0 13.0 13.9 14.9 15.8 16.8 17.7 10.0% 11.6 12.5 13.4 14.3 15.2 16.2 17.1 10.5% 11.2 12.1 12.9 13.8 14.7 15.6 16.4 11.0% 10.8 11.6 12.5 13.3 14.2 15.0 15.8 11.5% 10.4 11.2 12.0 12.8 13.6 14.5 15.3 12.0% 10.1 10.8 11.6 12.4 13.2 13.9 14.7 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 40.0% 1.8% 4.1% 6.3% 8.4% 10.4% 12.4% 14.3% 45.0% 1.2% 3.4% 5.6% 7.7% 9.7% 11.6% 13.5% 50.0% 0.5% 2.7% 4.9% 6.9% 8.9% 10.9% 12.7% 55.0% -0.2% 2.0% 4.1% 6.2% 8.2% 10.1% 11.9% 60.0% -1.0% 1.3% 3.4% 5.4% 7.4% 9.3% 11.1% 65.0% -1.7% 0.5% 2.6% 4.7% 6.6% 8.5% 10.3% 70.0% -2.4% -0.2% 1.9% 3.9% 5.8% 7.7% 9.5% 75.0% -3.2% -1.0% 1.1% 3.1% 5.0% 6.9% 8.7% 80.0% -3.9% -1.8% 0.3% 2.3% 4.2% 6.0% 7.8% 45.0% 20.9 20.1 19.4 18.7 18.0 17.3 16.7 16.1 15.5 40.0% 22.0 21.2 20.4 19.6 18.9 18.2 17.5 16.9 16.3

9.5x 16.1% 15.3% 14.5% 13.7% 12.9% 12.1% 11.3% 10.4% 9.6%

10.0x 17.8% 17.1% 16.3% 15.5% 14.6% 13.8% 13.0% 12.1% 11.2%

40

Underwriting 5% RPK growth drives IRRs of 15-18% and adds 5 GBP/sh. (87% upside)

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 valuation
2017E Exit: 3,487 Accumulated LFCF 29,536 Add: Exit at LTM EV/EBITDA 33,023 Realized Profit 20,211 Current EV 3 Holding Period (Years) 17.8% IRR 2022E Exit: 6,644 Accumulated LFCF 36,710 Add: Exit at LTM EV/EBITDA 43,354 Realized Profits 20,211 Current EV 5 Holding Period (Years) 16.5% IRR 20,639 66,197 86,836 20,211 10 15.7%

2015E Exit: Accumulated LFCF Add: Exit at LTM EV/EBITDA Realized Profits Current EV Holding Period (Years) IRR

41

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

42

Low historical cash flow generation

Analysts fixate on low historical cash flow generation From 2009 2011, firm generated no net free cash

Driven by 1.5B cash-funded Tognum acquisition in 2011

Variant view: analysts often drag forward 2012 TCA debtor (receivable) growth, which is incorrect

Management seems to sandbag on cash flow Includes capital payments in cash flow guidance Guided to breakeven in 2012, but generated 1.6B in free cash, or 650M excluding divestitures Guided to breakeven cash flow in 2013, but will earn 2.3B in EBITDA and only spend ~800M on CapEx Possible incentive for sandbagging cash flow: negotiating LTSA contracts with customers as sales cycle ramps In any case, RR is a highly cash generative business that should be reinvesting capital given its high ROICs
43

Defense sequestration

Type

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

~Unfilled Orders Status >174 7.6B EUR program, created by treaty -- any more cuts from core countries (France/Germany) below 170 28% Core orders will threaten the program. Cuts appear to have already happened Massive fighter program, with enormous potential (>2k JSFs in US alone), but equally scary cost/cost 100% >340 overruns. Highly susceptible to cuts; under pressure already. STOVLs are perhaps 10-20% of orders. 34% 140 Production rate cut by almost 50% in 2012; currently in Tranche 3 orders 50% ~150 Stressed program due to order cutbacks and late deliveries. 100% 98 Cut from 122 in early 2012 100% ~40 ~900 engines delivered. Producing at about 24/year, with rate going down Joint ~7.3B German/French program; some cuts have gone down in 2012, but Eurocopter doesn't expect 50% ~70 more cuts. 100% Few Very expensive program that might be mothballed. In JV with GE to produce an alternative to P&W's F135. Funding pulled by Congress in 2011; GE and RR are 40% 0 continuing to fund some R&D since they believe funding will return, just at a lower level.

49% of defense revenues from service, not OE

Engine Platform A400M F35-B JSF STOVL Variant Eurofighter Typhoon NHI NH90 V22 Osprey C130 J Hercules / C-27 RR Stake

Transport TP400 LiftCombat system Combat EJ200 Helis RTM322 Transport AE1107C Transport AE2100

Helis MTR390 Eurocopter Tiger Transport AE3007 Global Hawk Combat F136 F35

44

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

Civil service revenues highly correlated to global commercial air activity

Regression of civil service revenues vs. RPK (revenue passenger kilometers) from 2006 2011 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%

45

Technical mishaps

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

46

Competing against GE: the 500lb gorilla

GEs advantages:

Larger scale trailing revenues 1.5x RRs Deep pockets GE Capital can finance customers, and GE has bought 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 JVs given capital intensivity of industry, no player has the resources to go it alone

47

What happened to narrowbody?

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

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

Widebody smaller by units, but larger by $

Produc- In Prodtion Yrs. uction? 1997 2015 1988 Now 2017 2014 2015 2002 2014 Yes Yes Yes Yes Yes Yes Yes Yes # of Engines 2 2 2 2 2 2 2 2 # of Seats 110 - 210 124 - 236 107 - 220 126 - 180 300 - 400 150 -212 70 - 130 100 - 149 Operating* 4293 0 5234 0 0 0 908 0 Unfilled Orders 2010 1878 1751 1180 340 241 185 148 Total Orders 6303 1878 7153 1180 340 241 1093 148

ManufacCategory turer Model Narrow Narrow Narrow Narrow Narrow Narrow Narrow Boeing Airbus Airbus Boeing Comac 737 NG A320neo A320 737 MAX C919

Engine 1 Engine 1 Engine 2 Engine 2 Engine 1 Provider Share Engine 2 Provider Share CFM567B CFM 100% N/A N/A N/A PW1000 Pratt & LEAP-X CFM 60% G Whitney 40% Various CFM, PW, IAE engines N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A

Irkut MS-21 Embraer 190/195 BombarNarrow dier C-Series

LEAP-X CFM LEAP-1C CFM PW1000 Pratt & G Whitney CF34 GE PW 1500 Pratt & G Whitney

100% 100% 100% 100% 100%

48

Complex financing section of income statement

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

49

Earnings quality concern: capitalized recoverable engine costs

When engine OE sales generate a loss, they are occasionally capitalized in a recoverable engine costs account under intangible assets

Logic: engine will generate aftermarket profit, so loss is an asset Analysts concerned with the impact of this practice on quality of earnings

Mitigants

Logic is sound, as engine OEMs are generally only profitable on the aftermarket Negligible against scale of operations at peak in 2009, only 6.6% of Civil OE revenues Reversed in 2012: amortization of capitalized costs now larger than gross additions

50

Allegations of bribery

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

51

Source: Various news reports and filings, e.g. http://www.bbc.co.uk/news/business-20622911 http://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 extensive moats drive de-risked returns

Conservative assumptions yield 15 GBP target price (46% upside). ~12 15% IRR for 3 10 years with lower than equity risk.

1. Business in an oligopoly with high barriers to entry 2. Long-cycle business with extensive firm order book drives high certainty regarding growth: will overtake GE in widebody 3. Ample room for margin expansion via operating leverage 4. Return profile de-risked by conservative assumptions, defensive industry, 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

52

Agenda
1) 2) 3) 4) 5) 6) 7) 8)

Introduction and investment thesis Industry overview Barriers to entry Revenue growth Margin expansion Valuation Risks and mitigants Appendix

53

View vs. BAML

View vs. BAML Fiscal Year Ending Dec. 31st, 2013E 2014E 2015E 2016E Civil Aero Non-IAE Revenues BAML OE Projected OE
Divergence

Comments

3,274 3,181
-2.8%

3,842 3,967
3.3%

4,335 4,272
-1.5%

4,661 4,609
-1.1%

Unit installed base growth nearly identical.

BAML Service Projected Service

Divergence

3,005 3,792
26.2%

3,151 4,200
33.3%

3,476 4,656
33.9%

3,752 5,168
37.7%

BAML lags Trent installed base by 7 years for spares. For service revenues, just escalates by 7%.

BAML Consolidated Projected Consolidated

Divergence

6,279 6,973
11.1%

6,993 8,167
16.8%

7,811 8,927
14.3%

8,413 9,778
16.2%

Civil Aero Non-R&D Costs BAML Non-R&D Costs Projected Non-R&D Cash Costs BAML Non-R&D EBITDA Projected Non-R&D EBITDA
Divergence

4,983 5,560 1,296 1,413

9.0%

5,531 6,567 1,462 1,601

9.5%

6,134 7,120 1,677 1,808

7.8%

6,567 7,765 1,846 2,013

9.0%

BAML: 80% of OE and 50% of service costs are variable

BAML Gross Margin % Projected Gross Margin % Civil Aero Other Projected IAE Earnout BAML IAE Earnout Consolidated BAML Revenues Projected Revenues
Divergence

20.6% 20.3%

20.9% 19.6%

21.5% 20.3%

21.9% 20.6%

185 261

185 245

185 243

185 222

BAML projects out IAE growth in the earnout

15,181 15,720
3.5%

16,113 17,089
6.1%

17,110 18,027
5.4%

17,899 19,060
6.5%

Difference almost entirely attributable to Service revenues

BAML EBITDA (After removal of 50% of Energy Holdings, prefer to back 2,253 out here2,488 rather than 2,695 in MI) Projected EBITDA 2,309 2,490 2,702
Divergence 2.5% 0.1% 0.3%

2,893 2,912
0.6%

Projected EBITDA, using BAML's IAE

Divergence

2,386
5.9%

2,550
2.5%

2,761
2.5%

2,948
1.9%

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.

Cash Flow BAML UFCF Projected UFCF

Divergence

780 978
25.3%

1,139 1,093
-4.1%

1,504 1,348
-10.4%

1,450 1,464
0.9%

54

View vs. Citi

View vs. Citi 2013E Civil Aero Revenues Citi OE Projected OE
Divergence

Fiscal Year Ending Dec. 31st, 2014E 2015E 2016E 3,760 3,967
5.5%

Comments 2017E 5,010 4,920

-1.8%

3,270 3,181
-2.7%

4,140 4,272
3.2%

4,550 4,609
1.3%

Citi Service Projected Service

Divergence

3,560 3,792
6.5%

3,830 4,200
9.7%

4,120 4,656
13.0%

4,430 5,168
16.7%

4,760 5,735
20.5%

Citi projects by assuming 7.5% growth

Citi Civil Aero Total Projected Civil Aero Total

Divergence

6,830 6,973
2.1%

7,590 8,167
7.6%

8,260 8,927
8.1%

8,980 9,778
8.9%

9,770 10,656
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 Citi IAE Earnout 140 115 90 Citi Civil Aero Operating Income 860 1,010 1,170 Projected Civil Aero Operating Income 918 1,017 1,169
Divergence 6.7% 0.7% -0.1%

185 65 1,340 1,313

-2.0%

185 40 1,530 1,478

-3.4%

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

Consolidated Citi Revenues Projected Revenues

Divergence

15,430 15,720
1.9%

16,620 17,089
2.8%

17,770 18,027
1.4%

19,010 19,060
0.3%

20,360 20,123
-1.2%

Citi EBITDA (After removal of 50% of Energy Holdings, prefer to back 2,255 out here rather 2,502 than in 2,764 MI) Projected EBITDA 2,309 2,490 2,702
Divergence 2.4% -0.5% -2.2%

3,059 2,912
-4.8%

3,379 3,143
-7.0%

Divergence in Civil Aero offset by Citi's projected growth in other segments Citi projects robust margin improvement in other segments

55

View vs. UBS

View vs. UBS 2013E Civil Aero Revenues Broker OE Projected OE
Divergence

Fiscal Year Ending Dec. 31st, 2014E 2015E 2016E 3,341 3,967
18.7%

Comments 2017E 4,021 I'm ahead by 475 deliveries by 2017 -- most of street 4,920 agrees with me
22.4%

3,073 3,181
3.5%

3,573 4,272
19.6%

3,812 4,609
20.9%

Broker Service Projected Service

Divergence

3,883 3,792
-2.3%

4,187 4,200
0.3%

4,530 4,656
2.8%

4,907 5,168
5.3%

Broker Civil Aero Total Projected Civil Aero Total

Divergence

6,956 6,973
0.2%

7,528 8,167
8.5%

8,103 8,927
10.2%

8,719 9,778
12.1%

5,320 UBS assumes 3% from pricing (2% for me) 5,735 UBS assumes 4.5% uptake from RPK growth (I don't) 7.8% UBS ties service revenues to installed base (same) 9,340 10,656
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 Broker IAE Earnout 187 195 204 213 Broker Civil Aero EBITA (Pre-R&D) 1,357 1,421 1,452 1,504 Projected Civil Aero EBITA (Pre-R&D) 1,240 1,367 1,536 1,697
Divergence -8.6% -3.8% 5.7% 12.9%

185 213 1,653 UBS assumes an add-back of 356M from TCA debtors 1,879 per year; my front year TCA debtors is 175 and rises 13.6% to 321 by terminal year. Operating leverage drives the rest of the difference. 19,129 I get ahead on Civil Aero, offset somewhat by UBS's 20,123 projected 5% growth in rest of business. UBS has a 5.2% (150M) flat adjustment in all years. 2,720 Difference largely driven by Civil Aero and the fact 3,143 that UBS apparently double counts R&D -- bakes all 15.6% into Civil Aero but doesn't back out from other segs.

Consolidated Broker Revenues Projected Revenues

Divergence

15,788 15,720
-0.4%

16,533 17,089
3.4%

17,341 18,027
4.0%

18,220 19,060
4.6%

Broker EBITDA (After removal of 50% of Energy Holdings, prefer to back 2,346 out here 2,432 rather than 2,482 in MI) Projected EBITDA 2,309 2,490 2,702
Divergence -1.6% 2.4% 8.9%

2,537 2,912
14.7%

Cash Flow BAML UFCF Projected UFCF

Divergence

515 978
89.8%

720 1,093
51.7%

732 1,348
84.1%

777 1,464
88.3%

882 Difference driven by EBITDA, UBS growing TCA assets straight at 356M/yr (I have half that in front year), and huge capex ahistorical capex.

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Long-term time horizon drives variant view

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
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Variant view against other brokers

View vs. Street Fiscal Year Ending Dec. 31st, 2016E 2015E 2014E 2013E Civil Aero Revenues DB Estimate Jefferies Estimate RBC Estimate Projected
Divergence from Average

6,437 6,611 6,952 6,973

4.6%

7,233 7,135 7,786 8,167

10.6%

7,873 7,687 8,721 8,927

10.3%

8,361 9,778
16.9%

Civil Aero Underlying Income JPM Estimate Jefferies Estimate DB Estimate Projected
Divergence from Average

876 850 909 918

4.5%

1,007 925 1,031 1,017

3.0%

1,142 1,050 1,168 1,169

4.4%

1,273 1,200 1,313

6.2%

EPS Bloomberg Consensus Projected

Divergence

65.6 68.1
3.8%

71.9 73.9
2.8%

77.2 81.6
5.7%

83.4 89.1
6.8%

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Management compensation (2011)

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%

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Defense industry overview

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
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Defense portfolio

Note: I am not a defense analyst, so I guarantee that there will be errors in the following. Use only for a broad overview!
Engine Platform A400M F35-B JSF STOVL Variant Eurofighter Typhoon NHI NH90 V22 Osprey C130 J Hercules / C-27 RR Stake ~Unfilled Orders Status >174 7.6B EUR program, created by treaty -- any more cuts from core countries (France/Germany) below 170 28% Core orders will threaten the program. Cuts appear to have already happened Massive fighter program, with enormous potential (>2k JSFs in US alone), but equally scary cost/cost 100% >340 overruns. Highly susceptible to cuts; under pressure already. STOVLs are perhaps 10-20% of orders. 34% 140 Production rate cut by almost 50% in 2012; currently in Tranche 3 orders 50% ~150 Stressed program due to order cutbacks and late deliveries. 100% 98 Cut from 122 in early 2012 100% ~40 ~900 engines delivered. Producing at about 24/year, with rate going down Joint ~7.3B German/French program; some cuts have gone down in 2012, but Eurocopter doesn't expect 50% ~70 more cuts. 100% Few Very expensive program that might be mothballed. In JV with GE to produce an alternative to P&W's F135. Funding pulled by Congress in 2011; GE and RR are 40% 0 continuing to fund some R&D since they believe funding will return, just at a lower level. 50% 0 Retired in 2005/07 by France/UK; India upgrading fleet but RR decided not to tender 50% ~0 New orders primarily used as trainers 50% 0 Out of production 100% 0 Out of production 100% 0 Out of production 50% 0 Out of production 50% 0 Out of production 100% 0 Out of production 100% 0 Out of production 100% 0 Out of production 50% 50% 0 WAH-64D, which RR's engines are on, don't appear to be currently on order. 50% Few Seems to be only small export production now (Algeria recently ordered 6). 100% 0 Superceded by Super Lynx 0 Out of production, to be replaced by models such as NH 90.

Type

Transport TP400 LiftCombat system Combat EJ200 Helis RTM322 Transport AE1107C Transport AE2100

Helis MTR390 Eurocopter Tiger Transport AE3007 Global Hawk Combat Combat Combat Combat Combat Combat Trainers Trainers Transport Transport Transport Helis Helis Helis Helis Helis F136 Adour Adour Adour Pegasus RB199 Adour FJ44 T56 T56 T56 RTM322 RTM322 CTS800 Gem Gnome F35 SEPECAT Jaguar BAE Hawk Mitsubishi F-1 Harrier Tornado T-45 Goshawk Saab SK60 C130 A-H Hercules P-3C Orion E-2C Hawkeye Black Hawk Apache Super Lynx 300 Lynx Augusta Westland Sea King

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Defense outlook

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

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Marine segment overview

Key businesses:

Ship design and OE Designs 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 derivatives Provides engines for various uses LTSA covers 5% of services, clear opportunity for expansion

Key end markets:

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Offshore (47%) Primarily offshore oil and gas services. Should grow quickly as deepwater grows Merchant Specialist ships (e.g. cargo, tugs, yachts, etc.) Naval Serve as OEM to a range of naval applications

Energy segment overview

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

Provides aero-derivatives and centrifugal compressors for pumping both on 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 capabilities Systems and component engineering; reactor support; safety, licensing, and environmental engineering

Power generation (25%) aero derivatives and services 25% of service revenues covered by LTSAs
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Energy Holding segment overview

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

Bergen Supplies diesel and gas engines to marine segment and to external power generation customers Tognum Acquired 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

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Integration opportunities with marine and energy segments 296M of preliminary 2012 EBIT

Drivers of civil aero market growth

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 Region Asia Pacific Europe North America Middle East Latin America C.I.S. Africa Total 1,700 970 820 470 260 130 120 4,470
2012 to 2031

$B Airplanes 12,030 7,760 7,290 2,370 2,510 1,140 900 34,000

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Drivers of civil aero market growth (cont.)

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Source: Airbus market outlook, 2012-31

Pension assumptions slightly aggressive, but underfund is small relative to EV

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Source: 2012 FY press release, and 2011 Annual Report

C share structure

Dividends are paid in C shares, essentially a non-cumulative non-voting redeemable preferreds that can be redeemed for cash 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 LIBOR on 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

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Disclaimer: This presentation is the opinion of the author, and no representations or warranties are made as to its accuracy or completeness.