You’d think that with balance sheets full of cash, record high stock prices, and a record low cost of capital, corporate management teams and their newly-minted billionaire executives could afford to splurge on a private jet or two, but apparently, the outlook isn’t looking good for 2016.
On Thursday, Rolls Royce delivered a stunner of a profit warning as new CEO Warren East said the company will take a hit of some $990 million on expected “sharply lower” sales of corporate jets along with headwinds facing the offshore oil market where the company’s customers use vessels powered by Rolls Royce engines.
“The magnitude of change in some of our markets, which have historically performed well, has been significant and shows how sensitive parts of our business are to market conditions in the short term,” East noted, adding that “the fixed costs in this business are simply too high, so that small, relatively modest changes in the top line driven by market conditions just make too big an impact on our profit.”
Here are some other highlights from East's "review" (available here [9]):
- Although many Land & Sea businesses had good order intake in the quarter, the offshore business intake was very weak. New contracts included MT30 gas turbines for the Royal Navy’s Type 26 Global Combat Ship, MTU diesel engines for the refit of the Royal Navy’s fleet of Type 23 Frigates and a new agreement for the supply of engines for a range of Sunseeker luxury yachts.
- Compared to the expected outturn in 2015, the key areas of demand weakness are affecting selected aerospace and offshore marine markets. In aerospace, these mainly relate to the themes emerging in the third quarter, including sharply lower volumes of corporate jets powered by Rolls-Royce engines, further weakness in demand for corporate jet aftermarket services, further significant declines in aftermarket service demand for our engines on 50-70 seat regional jets and more conservative assumptions on demand reductions for some legacy programmes. Together, these impacts on our corporate and regional business account for roughly £100m of our incremental profit headwind.
- We have begun to see reduced utilisation by some specific operators of older wide-bodied engines. This management of short-term excess capacity, as the market takes delivery of newer, more fuel efficient airplanes, is already starting to impact aftermarket revenue and profit. Together with other changes, the incremental profit headwinds for our wide-bodied engine business are expected to be roughly £100-150m.
And then there was this: "Shareholder payments policy will be reviewed by the Board and changes, if any, will be announced in due course."
Right, so Rolls is may cut the dividend "in due course."
Needless to say, the market is not happy as shares plunged as much as 22% and CDS spiked:
[10]
[11]
Here's a bit of analyst color which amusingly includes a prediction that the company is facing a "classic near death experience" (via Bloomberg):
- AGENCY PARTNERS (sell, PT under review)
- Co. has cut forecast that’s only four months old
- Heading for a classic aerospace & defense “near-death experience,” with equity value squeezed by other liabilities
- Typically means 70%-80% decline in share price, which may fall into the 300s next year
- There are risks but has liquidity and U.K. PM Cameron “will not want to let this one go on his watch”
- Like Finmeccanica, another A&D near-death experience, upside will be very strong when it comes
- BERNSTEIN (market-perform, PT 815p)
- Says co. continuing to re-base expectations
- Co. said on call scope of review begun by new CEO East has widened since July to include portfolio of businesses
- Expect significant changes to organization, including simplifying structure, decision making and potentially accounting
- Addl headwinds GBP100m-GBP150m from lower aftermkt demand, including Trent 800 engines on older Boeing 777s; GBP100m from corporate/regional jets; GBP75m-GBP100m from oil&gas mkt weakness
- Investor day later this month will be focus
- HARGREAVES LANSDOWN (no rating)
- Review of its current shareholder payments policy a major negative
- Company’s earlier efforts to reduce earnings volatility and surprises seems to have been completely unwound
- Current consensus analyst rating of a “weak hold” will come under downward pressure despite sizable order book and mgmt changes
A bit more color from FT [12]:
The engineer been slashing jobs this year as it looks to cut costs and steady the ship. Last month it announced another 400 job cuts in its marine business, taking the total for the year to 1,000 in that business alone.
The new chief executive pledged that he would bring down costs further in response to the worsening conditions, but the benefits were not likely to begin coming through until 2017. Management layers would be stripped out and processes accelerated to deliver incremental savings of £150m-£200m. The group said it was on track for the £115m in cost savings already announced for 2016.
“This is not business as usual,” he said. “The disappointing outlook underlines the urgency and we need to get on with it.”
The announcement is likely to strengthen the hand of ValueAct, the US activist that emerged as one of the British blue-chip’s biggest shareholders in July with a 5.4 per cent stake. ValueAct has indicated that it wants Rolls-Royce to divest its marine business and focus on the civil aero-engine business that is surfing a boom in aircraft orders.
Of course I guess that depends on what FT means by "strengthening the hand." It may strengthen the activist's bargaining hand but seeing a company in which you own a large stake go through a "near death" experience isn't exactly what you want - just ask Bill Ackman.
Also, you know things are bad when the sellside has you at "Sell" (and this was before today's warning):
Finally, it's worth noting that the compay has already been bailed out by the UK once, and as Agency Partners notes above, "U.K. PM Cameron will not want to let this one go on his watch." Get ready UK taxpayers.
