A Rolls model to avoid

BLUE CHIP: Weak markets and an impatient City have sent shares in the aero-engine maker into a tailspin

THE CITY seems to have finally lost patience with Rolls-Royce - the aero-engine manufacturer, that is, not the more glamorous and successful car company.

After years of promising jam tomorrow, R-R still looks to be struggling. Recent poor results sparked a raft of downgrades - 11 at the last count - and a number of sell recommendations.

Some savage restructuring and the timely purchase of Allison, the US engine maker, have done little to address fundamental problems that are outside R-R's control. Both the power generation and, more importantly, the civil aircraft markets are weak.

Last week's welcome news of Saudi Arabia's $6bn (pounds 3.8bn) order for aircraft from Boeing and McDonnell Douglas will mean spin-off work for R-R. But such huge orders are the exception, not the rule, these days.

R-R's main customers, the airlines, have suffered the twin impact of declining passenger volumes and a drop in fares caused by deregulation.

Airlines are using aircraft longer and buying fewer spares, which are a high-margin contributor to profits. Boeing, which has cut production rates on certain aircraft, is facing a strike that could have a damaging knock-on effect for suppliers.

Aircraft orders rose 10 per cent in 1994, the first increase since 1988. But the production cycle lags orders by about 18-24 months. As Roger Hurn, chief executive of Smiths Industries, warned last week: "The civil aircraft market will reach its nadir in 1996."

Prospects for R-R's military engine business are more encouraging. The UK's recent purchase of Apache helicopters is helping to bridge a gap between Saudi Arabia's Tornado order and the expected business from Eurofighter - assuming no further delays in the latter.

In the intensely competitive engine market, R-R's two larger rivals, Pratt & Whitney and General Electric, have also cut costs and are generally regarded as being more efficient than their UK competitor.

Stockbroker BZW, perhaps the most pessimistic of the R-R Cassandras, believes further substantial reorganisation may be needed to restore margins. R-R's restructuring provisions have been spent, and further charges - even another rights issue - are on the cards. Closer ties, possibly a merger, with other European engine makers are rumoured, though these would involve short-term costs.

The depth of R-R's problems were underlined in half-time results announced last month. Aerospace profits grew pounds 3m to pounds 46m, but only because they were propped up by a pounds 21m cut in spending on research and development.

Not that things are looking much brighter on the industrial power side, where profits dipped pounds 7m to pounds 30m. They would have crashed without the pounds 23m raised from business disposals.

R-R is a relatively small player in the power sector, and the weak market means the operation has insufficient volumes and is not cost competitive. The division is expanding, particularly in India, but the country has a poor record for profitability.

R-R did not have an executive available to defend the business when approached by the Independent on Sunday, but in the past Sir Ralph Robins, chairman, has said all the gloom is misplaced.

He pointed to the recovery in airline profits, which should help sales. "We believe the civil aircraft market is going to grow and we will get our share of it," he said.

Despite his optimism, the watchwords for investors should be "extreme caution". R-R's history of unstable profits and cash flows may well continue, and another equity injection is possible. With earnings and profits likely to continue to be disappointing, several analysts believe R-R shares should be at a significant discount to the market average price/earnings ratio.

BZW believes that a p/e discount of at least 20 per cent is called for, suggesting a price of under 135p - Friday's closing price was 155p - even if the valuation is extended as far as 1997 earnings.

Nor should investors pin their hopes on a bid. First, a bidder, which would more than likely be one of R-R's few competitors, would come up against the anti-trust authorities. Second, the British Government is thought unlikely to lift foreign ownership restrictions, currently 29.5 per cent.

At the moment, there appears to be little to hold up the company's shares. Sell.

Rolls-Royce

Share price 547p 1994 1995* 1996*

Sales pounds 3.16bn pounds 3.45bn pounds 3.60bn Pre-tax profits pounds 104m pounds 155m pounds 190m Earnings per share 6.86p 9.13p 10.69p Dividend per share 5.0p 5.0p 5.5p Dividend cover 1.4 1.8 1.9 Gross yield 3.7 3.7 4.0

* Estimate

Travel
travel
News
Tim Vine has won the funniest joke award at the Edinburgh Festival 2014
peopleTim Vine, winner of the Funniest Joke of the Fringe award, has nigh-on 200 in his act. So how are they conceived?
Sport
sportBesiktas 0 Arsenal 0: Champions League qualifying first-leg match ends in stalemate in Istanbul
News
Jamie and Emily Pharro discovering their friend's prank
video
PROMOTED VIDEO
News
ebooksAn evocation of the conflict through the eyes of those who lived through it
Sport
Manchester United are believed to have made a £15m bid for Marcos Rojo
sportWinger Nani returns to Lisbon for a season-long loan as part of deal
News
news
News
i100
Arts and Entertainment
O'Toole as Cornelius Gallus in ‘Katherine of Alexandria’
filmSadly though, the Lawrence of Arabia star is not around to lend his own critique
Life and Style
fashion
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Business Anaylst

£60000 - £75000 per annum + BONUS + BENEFITS: Harrington Starr: Business Anal...

Senior Project Manager

£60000 - £90000 per annum + Bonus: Harrington Starr: Global leading Energy Tra...

Associate CXL Consultant

£40000 - £60000 per annum + BONUS + BENEFITS: Harrington Starr: CXL, Triple Po...

Oil & Energy Business Anaylst

£45000 - £75000 per annum + BONUS + BENEFITS: Harrington Starr: Harrington Sta...

Day In a Page

Ferguson: In the heartlands of America, a descent into madness

A descent into madness in America's heartlands

David Usborne arrived in Ferguson, Missouri to be greeted by a scene more redolent of Gaza and Afghanistan
BBC’s filming of raid at Sir Cliff’s home ‘may be result of corruption’

BBC faces corruption allegation over its Sir Cliff police raid coverage

Reporter’s relationship with police under scrutiny as DG is summoned by MPs to explain extensive live broadcast of swoop on singer’s home
Lauded therapist Harley Mille still in limbo as battle to stay in Britain drags on

Lauded therapist still in limbo as battle to stay in Britain drags on

Australian Harley Miller is as frustrated by court delays as she is with the idiosyncrasies of immigration law
Lewis Fry Richardson's weather forecasts changed the world. But could his predictions of war do the same?

Lewis Fry Richardson's weather forecasts changed the world...

But could his predictions of war do the same?
Kate Bush asks fans not to take photos at her London gigs: 'I want to have contact with the audience, not iPhones'

'I want to have contact with the audience, not iPhones'

Kate Bush asks fans not to take photos at her London gigs
Under-35s have rated gardening in their top five favourite leisure activities, but why?

Young at hort

Under-35s have rated gardening in their top five favourite leisure activities. But why are so many people are swapping sweaty clubs for leafy shrubs?
Tim Vine, winner of the Funniest Joke of the Fringe award: 'making a quip as funny as possible is an art'

Beyond a joke

Tim Vine, winner of the Funniest Joke of the Fringe award, has nigh-on 200 in his act. So how are they conceived?
The late Peter O'Toole shines in 'Katherine of Alexandria' despite illness

The late Peter O'Toole shines in 'Katherine of Alexandria' despite illness

Sadly though, the Lawrence of Arabia star is not around to lend his own critique
Wicken Fen in Cambridgeshire: The joy of camping in a wetland nature reserve and sleeping under the stars

A wild night out

Wicken Fen in Cambridgeshire offers a rare chance to camp in a wetland nature reserve
Comic Sans for Cancer exhibition: It’s the font that’s openly ridiculed for its jaunty style, but figures of fun have their fans

Comic Sans for Cancer exhibition

It’s the font that’s openly ridiculed for its jaunty style, but figures of fun have their fans
Besiktas vs Arsenal: Five things we learnt from the Champions League first-leg tie

Besiktas vs Arsenal

Five things we learnt from the Champions League first-leg tie
Rory McIlroy a smash hit on the US talk show circuit

Rory McIlroy a smash hit on the US talk show circuit

As the Northern Irishman prepares for the Barclays, he finds time to appear on TV in the States, where he’s now such a global superstar that he needs no introduction
Boy racer Max Verstappen stays relaxed over step up to Formula One

Boy racer Max Verstappen stays relaxed over step up to F1

The 16-year-old will become the sport’s youngest-ever driver when he makes his debut for Toro Rosso next season
Fear brings the enemies of Isis together at last

Fear brings the enemies of Isis together at last

But belated attempts to unite will be to no avail if the Sunni caliphate remains strong in Syria, says Patrick Cockburn
Charlie Gilmour: 'I wondered if I would end up killing myself in jail'

Charlie Gilmour: 'I wondered if I'd end up killing myself in jail'

Following last week's report on prison suicides, the former inmate asks how much progress we have made in the 50 years since the abolition of capital punishment