This analysis covers Rolls-Royce, a maker of jet engines for wide-body planes, in a duopoly with GE Aerospace. Graeme Forster argues Rolls-Royce has great engineering but historically weak business sense, earning lower margins than GE. The new CEO is using the post-COVID crisis to cut costs and renegotiate contracts, aiming to lift margins from ~13% to higher teens. Forster is cautiously optimistic but warns engine failures are a key risk. Key holdings: Rolls-Royce (restructuring, margin upside), GE Aerospace (benchmark, higher margins), and SMR nuclear reactors (huge long-term potential, early stage).
At a Glance This edition of Business Breakdowns provides an in-depth analysis of Rolls-Royce’s core business—the wide-body aircraft engine market. Guest Graeme Forster notes that this market is a duopoly shared between Rolls-Royce and GE Aviation, but the company has historically experienced ups and
Graeme Forster (Orbis Investments) provides an in-depth analysis of Rolls-Royce, one of the two duopolists in the wide-body aircraft engine market. Forster’s core thesis is that Rolls-Royce possesses a strong engineering culture but has historically failed to fully capture the economic value warranted by its technological leadership due to weak commercial strategies; the current management is leveraging the "burning platform" created by the COVID crisis to drive structural change. If successful, the company could see its margins rise from low-teens to high-teens, but the "trust game" has yet to be won.
Graeme Forster argues that Rolls-Royce forms a stable duopoly with GE Aerospace in the widebody aircraft engine market, but has historically failed to convert its market position into profits as effectively as GE.
> Forster's original quote: "If you look at a GE in the US, a bit more commercially minded, they've managed to generate more profit and more margin from that business both on the cost side and on the revenue side."
Forster traces the root of Rolls-Royce’s troubles to its founding culture—engineering excellence above all, with commercial capabilities long neglected.
Forster argues that COVID was both a devastating blow for Rolls-Royce and a catalyst for driving long-overdue necessary changes.
> Forster's original quote: "Never waste a good crisis."
Forster believes that Rolls-Royce's potential in small modular reactors (SMR) is "absolutely enormous" and could become a core driver of the company's long-term value.
Forster shared the lesson he learned from investing in Rolls-Royce — "sometimes it is useful to look at a crisis from a different perspective."
| Position | Analyst Stance | Key Data |
|---|---|---|
| Rolls-Royce | Bullish (structural improvement underway) | Civil aviation margin low teens → target high teens; GE Aviation margin low 20s; expected free cash flow of £3-4 billion per year over the next 4-5 years |
| GE Aerospace | Benchmark reference | Margin low 20s, partly due to larger narrowbody engine scale |
| Airbus | Client/Partner | A350 exclusively uses Rolls-Royce XWB engines; A330 Neo exclusively uses Trent 7000 |
| Boeing | Client (limited impact) | 787 uses Trent 1000; current narrowbody issues have limited impact on Rolls-Royce |
1. Forster believes that Rolls-Royce's fundamental problem is "engineering culture overwhelming commercial culture" — after the early death of founding partner Charles Rolls, Henry Royce's engineering-first philosophy dominated the company for a century, leading to pricing and cost control persistently lagging behind GE. Supporting evidence: GE Aviation's profit margin is approximately 8-10 percentage points higher than Rolls-Royce's, and this gap cannot be explained by scale alone.
2. Forster compares LTSA to "direct insurance" — charging by flight hour, bearing all maintenance and tail-event risks, with no intermediary layer taking a cut. "The insurance industry is highly profitable because tail-event risks are too expensive for customers to bear." Supporting evidence: If priced correctly, LTSA should be a very good cyclical business, but Rolls-Royce has historically failed on both the pricing and cost sides.
3. Forster points out that COVID's impact on Rolls-Royce was unique — it lost revenue, not just profit — "Most businesses lose profit during a recession, but they don't lose revenue. Rolls-Royce lost revenue." Supporting evidence: The global grounding of aircraft caused flight-hour-based revenue to drop to zero, forcing the company to raise capital on a massive scale.
4. Forster believes the crisis created a "burning platform," enabling management to implement reforms impossible under normal circumstances — "Never waste a good crisis." Supporting evidence: When new CEO Tufan took office in 2022, "the platform was burning," allowing him to review costs item by item and renegotiate contract terms with customers.
5. Forster estimates that the SMR nuclear reactor market is worth £100 billion in the UK alone and trillions globally — The UK needs to increase nuclear capacity from 6 GW to 24 GW (2050 target), requiring 50+ SMRs, each costing £150-200 million. Supporting evidence: Rolls-Royce has already obtained partial UK regulatory approval and is likely to become a flagship player; even with just a 10% global market share, the revenue potential is "absolutely enormous."
6. Forster emphasizes that the engine industry faces an "efficiency race trap" — similar to the wind power industry, continuously launching more efficient new models destroys orders for older models and R&D investment. Supporting evidence: The industry has now become more rational, waiting for technology to mature sufficiently before launching the next-generation engine (expected in the early 2030s), with a 5-6 year R&D calm period in between.
7. Forster believes the current widebody aircraft market faces a "structural supply shortage" — production disruptions during COVID created a supply gap, while demand has recovered to a GDP+ growth trend. Supporting evidence: This gap cannot be filled all at once, forming a gradual tailwind over 5-7 years, making the order backlog very reliable.
8. Forster concludes from his investment experience: turnarounds are extremely difficult in normal times, but crises may create the best entry points — Orbis invested in 2015, with progress far slower than expected; the COVID crisis provided a "burning platform," making change possible. "Sometimes it is beneficial to view a crisis from a different perspective — focusing on whether it can trigger structural change."