ROLLS-ROYCE – TROUBLE AHEAD?
By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.
05 Nov 14. Being less than three weeks since the company had announced a second profit warning this year – this last one based on a deteriorating economic environment impacting on revenue blaming in part a mix of a barely growing Eurozone economy and the slowdown in Asia and South America plus some minimal effect of western sanctions on Russia – I readily admit to having been surprised at the swiftness of announcement from Rolls-Royce that all of a sudden it now proposed to shed 2,600 jobs over the next eighteen months as part of its ongoing cost reduction programme.
I suspect that from a timing point of view in what looked a rather hastily written announcement document it was the use of the word ‘accelerates’ that worried me most. Rolls-Royce says that the jobs that will go would be principally from its Aerospace division and it also warned in the statement that there may well be more job losses to come.
In the knowledge that Rolls-Royce has an order book of £70 billion of which roughly £60 billion is for civil aircraft engines I might be entitled to question the timing of the announcement believing that there may just be an element of attempting to appease the ‘city’ in this following the extremely negative reaction afforded the shares on the day of the second profit warning announcement on October 17th.
This is a global company of course and today Rolls-Royce employs approximately 55,200 people worldwide of which around 24,800 are employed in Britain. In terms of civil aircraft engine development and manufacturing the strategy over the past thirty-years has been about placing strong emphasis on research and development based product development to create aircraft engines that have technical qualities over and above those of its two large US based competitors, selling those engines to a far wider group of international airline customers and in doing so, increasing market share.
In achieving the success that is has and that has been based on long term strategy Rolls-Royce is today the world number two in civil aero engine sales. The strategy has also been based on implementation of constant engineering and manufacturing improvement processes, thinking out of the box and beyond if you like, training and skills growth and the provision of excellent graduate and apprenticeship schemes. For those that had been prepared to share risk in what was called ‘risk revenue sharing [development] partnerships the benefits would be apparent through the vast increase in market share gained and number of engines in service with international airline customers.
For investors the bottom line would be that as this process developed and matured strong profitability would emerge based on incremental revenue benefit created through increased levels of maintenance, repair and overhaul (MRO) business together with spares.
Rolls-Royce doesn’t just make civil aero engines of course as this is a diverse engineering group that makes power plants for ships, military aircraft engines including those fitted to Eurofighter Typhoon and BAE Hawk T2, through its original purchase of Vickers, propellers, steering and braking equipment for ships, diesel engines, nuclear engineering and other large products for the oil and gas industry. Rolls-Royce also manufactures gas turbines and compressors for the energy industry although, as previously announced, this division has been sold to Siemens in Germany.
In the second profit warning last month Rolls-Royce management cut its revenue forecast from a previous flat expectation to one that now anticipated the current financial year to see a 4% decline. While the company stuck to its current year flat profits expectation it suggested that it also anticipated no return to growth in 2015 and that underlying profits would be flat to 3% lower next year on revenue that would be in a +3% to -3% range. For