Warren East learns quickly. Regular profit warnings have become something of a tradition at Rolls-Royce and, just two days into his tenure as chief executive, Mr East has released one of his own. Perhaps this is the usual kitchen sinking: an early lowering of expectations that will make future outperformance easier to achieve. But the scale of Monday’s share price fall — 9 per cent — is nearly twice the size of the 5 per cent cut to current year forecasts. The shares now trade on 13 times those revised earnings — a discount to the forward PE of 15 that has been the group’s average over the past five years.
A harsh judgment, perhaps. After all, some of Rolls’s problems come from the marine business, which has been hurt by a drop in activity relating to the oil and gas sector. That part of the business had been expected to make a profit of £90m-£120m this year, but might now only break even. But Rolls is hardly alone here — most companies that serve the oil and gas industry are having a rotten year. In any case, marine is only 12 per cent of group revenues. Rolls should be able to cope with the weakness.
The other area of weakness is more concerning. The civil aerospace business (half of revenues) is also having problems. The Trent 700 engines, used to power the Airbus A330, are slowly making way for the Trent 7000 engines that power the A330neo, Airbus’s answer to the Boeing 787 Dreamliner. But the pace of the transition is proving hard to predict and sales of the Trent 700 are dropping off more quickly than anticipated. The impact from that (and from softness in the business jet market) will be offset by provision releases this year, but profits from civil aerospace next year will be £300m lower than expected.
This is a core part of Rolls-Royce’s business. Developing, selling and maintaining engines is what engine makers do. Yet the company is having trouble predicting how that process will go. And so its profits are less predictable too. It is that lack of visibility, as much as the underlying problems themselves, that is worrying.
The combination of an economically sensitive end market and a very long product development cycle means ups and downs are inevitable; that should be priced in. But Rolls’s failure to anticipate and communicate stands out from peers. It deserves every bit of its lower valuation.
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