View from City Road: Rolls running up a down escalator

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Despite spending pounds 85m on restructuring its aero engine division in the past two years Rolls-Royce would have reported a small loss in aerospace in 1993 on pounds 2.1bn of sales, had it not enjoyed a pounds 23m benefit from a rising dollar.

This seems a poor return indeed for all the sites closed and thousands of lost jobs. But it is a measure of just how tough the aerospace market is. There is no real sign of any upturn at the moment - rather the reverse.

As fast as Rolls-Royce has cut costs, its turnover has fallen on the back of a downward trend in civil engine deliveries and flat demand for its lucrative spare parts. The sensation of trying to run up a down escalator will continue into 1994 with engine deliveries set to slide again.

Rolls-Royce clearly underestimated the scale of the continuing downturn. Within the hefty pounds 230m exceptional provision set aside last year, it is raiding pounds 20m of the pounds 50m set aside to meet 'customer problems' to pay for accelerated rationalisation.

The full benefit of cost savings that in theory will run at pounds 100m a year will not show through until engine sales at least stabilise and spares demand turns up significantly. This is unlikely until late 1995 or 1996 when military business is set to jump.

Pressure on aerospace profits will be eased by a drop in research and development, up from pounds 229m to pounds 253m at group level, now that the peak of work on its Trent engine has passed.

Fortunately, as a result of last year's pounds 307m rights issue, Rolls- Royce has net cash in its balance sheet against shareholders' funds of pounds 1.2bn. The company has also been busily generating funds to pay for the restructuring by ripping another pounds 160m out of working capital, although sizeable inventory reductions may have cost pounds 40m to pounds 50m in lost operating profit.

Such financial solidity, coupled with stable prospects for power engineering after a setback in 1993, means that there is little to fear for the dividend even though the 5p payment was barely covered by 5.95p of earnings in 1993 after a subnormal 24 per cent tax charge.

But a market yield of 3.5 per cent at 179.5p, with no early prospect of dividend growth, may put off all but long-term holders.