Rolls-Royce

13 Feb 2014. Global defence cuts may have reasoned a more cautionary stance on FY14’s forward outlook guidance from senior management but that takes nothing away from the fact that 2013 was yet another year of superb financial performance at Rolls-Royce. Nevertheless, on the back of the more cautionary guidance that anticipates further negative impact to group revenue and profit performance (caused through the impact of ongoing global defence cuts) the company has confirmed that 2014 profit performance is likely to be relatively flat – even if a resumption of growth is expected 2015.

Whilst forward guidance is hugely important I have to say that I am somewhat surprised that analysts appear to have been caught off guard; US and UK cuts in defence spending have been long-trailed. While the impact of cuts to defence spending are worrisome, I take the view that given the overall size of defence-related activity within the overall portfolio of interests, initial concern is being overdone. Indeed, given the still huge growth potential evident in the vast majority of other activities in which the company engages, the prospect of lower revenue and profits in the defence division (a 15% to 20% decline in FY14 revenue is being forecast) together with an anticipated slowing in the Marine division justifies a 9% fall in the price of the shares. There we are – as a good capitalist I take the view that markets are, of course, almost always to be considered right but it seems to me that Rolls-Royce has nevertheless received poor treatment given its diversified engineering prowess and superb international standing.

Year after year Rolls-Royce drives better performance on the back of its strength in the aerospace engine market; the strategy remains to concentrate on gas turbine and reciprocal engine technology. Customer, Concentration, Cost and Cash remain the priorities for management but, just as important, is the company’s continued investment in people and R&D. Obviously more needs to be done on cost – and this is fully recognised by senior management  -but that is not to suggest that this fine company is anything other than close to the top of its game in terms of engineering ability, manufacturing efficiency, international competitiveness and people. Serious though any specific downturn in divisional activity is, I am then far less concerned than some at the impact of (what I hope will be) a relatively short period of negligible investment in the defence and marine markets.

The FY2103 report card makes for positive reading an can be summarised as: order book up 19% to £71.6bn (£60bn of which is within the Civil Aerospace business); underlying revenue up 27% to £15.5bn; underlying pre-tax profits up 23% to £1.759m; and proposed shareholder dividend up 13%. Tognum, now part of the Power Systems division, was consolidated in group results for the first time, whilst cash flow further improved with the company ending the year with a small net cash balance of £350m. Capital expenditure excluding Tognum was £687m, well up on the £491m spent in 2012, whilst free cash flow for the year was £781m. The balance sheet remains very strong with net assets of £6.3bn.

For the record 2013 achieved a number of interesting milestones for Rolls-Royce. On new gas turbine related programmes the Airbus A350 XWB which is powered by Trent XWB engines flew for the first time. The A350 programme is clearly progressing apace and this bodes well for Rolls-Royce as the manufacturer of the Trent XWB. To date the company has received orders for more than 1,600 XWBs, making this by far the best-selling member of the Trent engine family in terms of overall sales. The Trent 1,000 engine (used to power the Boeing 787 Dreamliner) has according to RR achieved the best performance of any new wide-body aircraft engine entering service, with no less than 99.9% dispatch reliability. Singapore Airlines is one of several airlines that last year chose to acquire the Trent 1000 to power fifty 787 aircraft ordered from Boeing.

Meanwhile in the Marine division, the first of four innovative Environ ships went to sea. According to Rolls-Royce this vessel combines a wave-piercing bow, gas-powered engines and advanced propulsion systems that together reduce CO2 emissions by 40%, compared with equivalent diesel-powered vessels.  In addition, BAE Systems announced that the UK’s Type 26 Destroyer programme will feature four MTU diesel generating sets from Power Systems, together with the Trent-derived MT30 gas turbine power unit.

All in all, a great set of results and although there is always room for improvement, given the record of success achieved by Rolls-Royce’s management over the years, I am in little doubt that further success will return in the form of regular growth by 2015.

Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
Tel: +44 7710 779785
Email: hwheeldon@wheeldonstrategic.com

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