Rolls-Royce Chief Reveals Repair-Costs Rethink Amid Airline Ire

  • East revamps overhaul deals that deliver bulk of earnings
  • Inflexible approach has hurt value of Trent-powered jets

In between Friday’s headlines on reduced dividends and job cuts, and a share price that soared the most in 12 years, Rolls-Royce Holdings PlcChief Executive Officer Warren East outlined nothing short of a revolution at the U.K. aircraft engine maker.

East conceded that all-encompassing maintenance packages, a key profit driver since their introduction two decades ago, are burdening older planes by limiting overhaul options and hurting resale values. Airlines are now seeking a “pay-as-you-go” model for turbines on used jets, he said.

Warren East

Photographer: Simon Dawson/Bloomberg

Repair contracts account for almost two-thirds of engine earnings at Rolls-Royce, with the London-based company generally selling turbines at a loss while signing up about 80 percent of buyers to its high-margin premium overhaul package, known as TotalCare.

“If we’ve got an old engine that customers are only going to keep for a relatively limited period of time, then tying in a long period of service agreement doesn’t make sense,” East said Friday on a call with analysts. The CEO warned in November that lower utilization of the older planes Rolls powers would contribute to a 350 million-pound ($507 million) earnings hit in 2016.

Flex Plan

Rolls is seeking to address the issue with its new TotalCare Flex deal, giving airlines more say over timing shop visits and choosing spares that can come at double the price direct from the manufacturer. The first clients include Cathay Pacific Airways Ltd. and South African Airways. A second package, SelectCare, covers new engines and pitched between TotalCare and ad hoc maintenance. American Airlines was announced as the first customer on Jan. 13.

The biggest carriers are also being granted the right to oversee work, led by Delta Air Lines Inc., whose in-house maintenance arm won Rolls approval in October. The step means the U.S. carrier, which last year said a glut of wide-bodies had driven prices for 10-year-old 777s as low as $10 million, can cannibalize its engines for parts rather than just sell jets for a pittance.

Rolls-Royce is also encouraging competition between its servicing ventures, especially in Southeast Asia, where Malaysian Airlines and Thai Airways International PCL are among carriers that have idled large numbers of planes.

Lower Residual

A 15-year-old Rolls-powered Boeing Co. 777-200ER is worth $2 million less than a General Electric Co.-fitted model, according to valuation specialists Oriel. East wants to address that situation while minimizing the impact on a TotalCare business that contributes such a large chunk of earnings.

“If we’re delivering real value then we stand a much better chance when it comes to the front end when signing up the longer-term agreements in the first place,” East said, adding that relaxing overhaul ties is also necessary as the number of Rolls engines flying doubles with the ramp up of Airbus 350 and Boeing 787 output.

East’s approach is a far cry from a spat with Air France-KLM Group in 2012 that saw Europe’s biggest airline hold off on ordering 25 Airbus A350, available only with Rolls engines, after the U.K. company refused to let the carrier overhaul the turbines at its own engineering division. The two sides later reached a compromise granting Air France a maintenance role.

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