Can Rolls-Royce beat its engine troubles?
Investors will need patience before profits start to take off
ROLLS-ROYCE’S biggest strength has always been its prestige.
Even though it separated from the car-making part of the business in the 1970s, the engineering and aerospace firm that remained has enjoyed the same reputation.
It is one of just two companies – alongside BAE Systems – in which the Government has a so-called ‘golden share’, meaning it is so strategically important that the state can block a sale of it to an overseas buyer.
But its esteem has suffered in the wake of problems with its Trent 1000 engines.
These have been a headache for Rolls since 2016, when it was discovered that the engines’ turbine blades were wearing out quicker than expected.
The clean-up costs associated with fixing the Trent 1000s have spiralled to £2.4bn between 2017 and 2023.
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OnE- Off charge of £1.4bn this year will knock profits as it takes on additional maintenance staff and builds spare engines to minimise further disruption to its customers such as British Airways- owner IAG, whose chief executive Willie Walsh has complained the debacle has been ‘frustrating and annoying’.
Credit rating agency Moody’s downgraded Rolls to Baa1 – just three notches above junk status – in August over concerns about the cash it has available and the mounting Trent 1000 costs. Beyond the Trent problems, Rolls has also come under fire from bearish brokers who say it has shot itself in the foot by focusing on making engines for big, widebody commercial planes instead of mid-sized jets.
These planes are predicted to be aerospace’s big growth area – and Rolls was stung by Airbus’ decision to pull its A380 jets, the biggest commercial jets ever designed, earlier this year due to a lack of demand.
And all of this has come as chief executive Warren East, in the role since mid-2015, has been trying to radically simplify the business.
He unveiled a plan in 2016 to streamline operations and cut jobs – 4,600 by the end of next year – in a strategy that took aim at a bloated middle management tier more reminiscent of the civil service than a footsie stalwart.
Unfortunately for East, the Trent 1000 turbulence has shaved off many of the gains Rolls shares had made under his tenure.
The stock reached a high of 1062p in August 2018, when the company was valued at around £20bn, but had fallen to 733.2p by last night, valuing it at £14.2bn.
In many ways, then, Rolls is a tricky punt for retail investors.
The recent problems have split analysts’ opinions, with ratings on the stock covering the full spectrum of recommendations from ‘strong buy’ to ‘strong sell’.
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analyst Russ Mould at AJ Bell says: ‘I have long since parked Rolls in the “too difficult” drawer. The company is complex, the accounting is dense, the Trent 1000 issue is clearly a big challenge, there’s no yield to speak of and on a forward-earnings basis it does not look cheap for 2019 and 2020.
‘You could argue this is because earnings are depressed, but you have to look a good way out and factor in a healthy earnings recovery to make its shares eye-catching. There are lots of “ifs” here – so I’d be inclined just to leave it alone.’
With a share price that has fallen by 10pc this year, anyone looking for a quick buck could be better off steering clear of Rolls.
But if there is reason to be optimistic about Rolls, it is as a longterm opportunity.
Sandy Morris, equity analyst at Jefferies, which gives Rolls a ‘buy’ rating, says: ‘Ultimately it’s going to generate much more cash and those uplands will remain sunny for a decade or more. East was handed not just one nasty problem but four or five all in quick succession.
‘It is slowly getting to grips with the issues and keeping us all informed about what’s going on.
‘Once the Trent 1000 engine problems are fixed, the company’s available cash will rocket from around £600m to £1.1bn.’
What also goes under-appreciated is that Rolls is involved in a number of emerging technologies.
It is leading a consortium which this month was handed £18m by the Government to design small nuclear reactors, injecting fresh hope that Britain’s nuclear sector is set for a revival after several big new-build projects were shelved.
And it is using its engineering expertise to design hybrid electric aircraft engines, partnering with the likes of Airbus.
Rolls has had a bad run and its short-term performance is still likely to be dominated by the Trent 1000 clean-up.
But patient investors could see handsome rewards when the company is free of the Trent troubles and has a seat in the front row of new, cutting-edge industries.