Rolls Royce share decline accelerates after profit warning

Rolls-Royce Holdings has been the main stock in focus on Friday after the company admitted it wouldn’t make a profit next year, sending the shares almost 15% lower.

The FTSE 100-listed aerospace and defence manufacturer warned its profits would not grow in 2015, contradicting its own previous guidance that profits would grow.

The firm, which is also the second-largest manufacturer of commercial jet-engines in the world (General Electric is No.1) said economic conditions had deteriorated, leading customers to delay decisions.

Rolls now estimates flat or as much as 3% lower underlying profit next year compared to this year.

Rolls also said this year’s results will be affected by the same issues which will damp 2015.

Its guidance for current-year underlying revenue is that it will come in 3.5%-4% lower. The guidance is calculated with an already-reported foreign exchange impact of £500m stripped out. Before, the company forecasted a flat performance year-on-year.

Underlying profit this year will still be flat versus to 2013, if negative currency effects and one-off factors are stripped, the company said. It cited improved cost performance for expected better underlying profit this year.

Tightening Russian trade sanctions are another factor that has weighed on earnings Rolls said. It noted orders were being cancelled and delayed in nuclear and energy and power systems businesses.

“In the past few months economic conditions have deteriorated and Russian trade sanctions have tightened, leading a number of customers to delay or cancel orders particularly in our Nuclear & Energy and Power Systems businesses,” Rolls-Royce said in a statement.

“At the same time we have made good progress on cost which has limited the impact of these adverse trading conditions on the group,” it added.

Profit warnings, governance shocks

The profit warning is not the first major disappointment for investors from the group this year.

In February it said US and European spending cuts in defence would result in flat profits in 2014, bringing over a decade of profit growth to an end.

The company has enjoyed 11 years of strong profit and revenue growth amid demand for fuel-efficient engines for passenger planes from Rolls Royce’s civil aerospace unit, which accounts for about half of its sales.

Rolls has also given new medium-term guidance today, saying it expected group return on sales of 13.5%-to-14.5%

On top of the earnings warning, investors will of course have a further concern about Rolls in mind, although it might not be their upper-most concern.

It’s that the company also seems to be racking up a list of regulatory issues around the world, including an on-going investigation by the UK’s Serious Fraud Office.

In December 2013 the SFO had launched a formal investigation into concerns of possible bribery and corruption in China and Indonesia.

Additionally, earlier this month it emerged Rolls-Royce was being investigated by India’s Attorney General, after allegations it made irregular payments before securing a maintenance contract with one of the largest aerospace companies in India. India decided earlier this week not to blacklist the firm during the investigation.

Bid to restore investor confidence hasn’t gone to plan

Clearly though, Rolls-Royce Holdings’ most pressing issue for the time being is profit growth, or the forecast lack thereof.

Rolls has confirmed this morning what a number of investors may have spotted in January. That deals were becoming less lucrative, and perhaps margins were at risk of if not a crunch at some point in the nearby years, then still a period of more fallow returns than the firm has managed in the last ten years.

Rolls-Royce Holdings Plc. deal value, 2004-2014. Source: Thomson Reuters

Investors may also have pause to question the announcement Rolls made in June of a $1bn cash return to shareholders on top of dividends.

It said it would return £1bn to shareholders instead of buying another company as some investors had speculated before the share buyback programme was announced.

The move was aimed at restoring investors’ confidence, the company said.

Confidence in the company has been shaken this year by an acquisition attempt followed by its first profits warning of the year and an engine order cancellation in May.

At the time of the announced cash-return, Rolls reiterated that it was on track for flat earnings this year and to return to growth in 2015, when it is due to ramp up aero engine production.

To some extent then, Rolls has managed to introduce an element of uncertainty into the minds of its investors by its actions this year.

Investors are therefore less likely to take as lenient a view of the firm’s free cash flow trend which entered a period of volatility in 2012, going cash-flow negative and positive for each half-yearly period since and cash-flow negative at the most recent half-way point by £440m.

In fact, confidence in Rolls could be said to have reached a historical inflection point, amongst investors earlier this year, judging by the virtual ‘lifetime’ chart below.

The stock has definitively fallen out of the uptrend which has cradled it since 2009.

The stock has come to a natural pause at the current level, for relatively sound reasons.

A shorter-term time frame (180 minutes) perhaps predictably, suggests selling could be close to exhaustion for the short term.

Finally, here is a screen shot of City Index’s new social trading platform, Connect, using real-time data from all users of City Index’s trading network dealing in Rolls Royce. It was taken on Friday 17th October, around 1400 BST.