ROLLS-ROYCE STRUGGLES TO PLEASE
By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.
16 Oct 14. That aerospace, marine, energy and nuclear power engineering business Rolls-Royce has been forced to warn that it will not return to growth during 2015 having previously believed that it would is both disappointing and worrying. No real surprise that the shares fell 0ver 8% in early morning trade today.
In a statement issued through the London Stock Exchange Rolls-Royce said that economic conditions had deteriorated and that in some parts of its business customers have been delaying order decisions and also cancelling orders. The result is that RR now expects 2015 underlying profits to be flat on revenue that will emerge within a range of either 3% higher or lower. Current FY14 expectations are for flat profits to emerge on revenue hit by a previously announced £500m foreign exchange hit will be in a range 3.5% to 4% lower than that of last year.
In the knowledge that a one percent movement in the average US$ rate will affect underlying revenue and profits at RR on an annual basis by £15m and £2.5m respectively and that a one percent movement in the average rate of the Euro will impact on underlying revenue and profits on an annual basis by £40m and £4m respectively it does not require too much imagination to work out that currencies have been going the wrong way. Hedging provides a certain level of relief of course if done wisely but the essential problem will always remain.
Damaged by defence spending cuts in the US, UK and Continental Europe and as the half year statement in July conformed, a one off product quality charge in the marine business, lower volume, higher restructuring and research and development costs plus expectation that adverse currency momentum is likely to continue perhaps we should not have been quite so surprised by the profit warning statement today. For now, except in terms of producing even greater efficiency of operation, there seems little that the company can do to reverse the trend although at least there should be no repeat of one-off marine division cost next year.
In looking deeper into at Rolls-Royce we still find a very well-constructed diverse engineering group based on a strategy of long term growth and that, despite the statement put out by the company today, will continue to thrive and prosper. This is after all a long lead business and one that has invested in its future. There can be nothing short term about Rolls-Royce and the future will always be based on pursuance of a long term strategy of earnings potential. Personally I have long disliked forward outlook statements made by companies to provide guidance to analysts but have little choice but to except them.
Of course, just because the forward strategy does not mean that the company can ignore short term implications. Currency momentum is one such aspect. That RR like others such as Airbus suffer the ongoing problem that of almost all global aerospace and a large part of defence business activity is priced internationally in dollars means that foreign exchange momentum will always be considered a risk. Investors know that and for the most part they live with it but I dare say that RR management must also learn to be touch more cautious from now on in its forward looking guidance statements. That is not to suggest that a revenue and profit warning did not exist in the July interim statement, simply that it probably was not cautious enough.
More worrying maybe the indication from RR management that free cash flow will decline to around £350m this year, a figure that is less than half the previous forecast which, if I remember correctly, was roughly similar to the £780m reported in FY13. For all that RR remains in a very strong financial and operational position not only as a company but also within the various spheres of industrial engineering activities in which it engages. The forward order book at h