I last wrote on Rolls Royce (RR.) in September, concluding I ultimately saw the shares testing the high of the last 52 week range at c. 10 quid again. And despite what was undoubtedly a very messy latest update, I retain that view. The real key is that Rolls Royce has one great asset and that is its widebody civil engine delivery capability of 500 engines a year which is augmenting its current 6,500 installed base in this area (the company has around 13,000 commercial aircraft engines in operation around the world). Sadly there has been a bunch of maintenance problems and the all-in bill has now risen to £3.2 billion which gives 'greater certainty to customers and clarity to investors' as apparently it has got a fix for eight of the nine problems on three different variants of the Trent 1000 engine.
Well that's pretty expensive and even when you adjust the earnings for all the extra expenses and the like, the company noted that operating profits will be towards the bottom of the £600 million to £800 million range being touted by the company beforehand as full year 2019 guidance. And for a company with a market cap of just shy of £15 billion (and c. £2 billion of net debt additionally), this puts the stock at a rather firm valuation – although the c. £700 million free cash flow (and continued maintenance of a £1 billion free cash flow target for 2020) does provide some hope.
And this is the key aspect with Rolls Royce. It is a long cycle stock, which means that fund manager types ponder the values of installed bases and servicing agreements and the like. They are right to do so as everything in the civil (and military) game is longer-term with multi-decade contracts and agreements. The military division had a useful x1.5 book-to-bill ratio (helped out by work on the F-35 aircraft) and then there is the Power division where the company notes (a bit self-importantly) that it 'pioneers cutting edge technologies that deliver clean, safe and competitive solutions to meet our planet’s vital power needs'. It had a growing order book here too.
Bottom line is, the full £3.2 billion charge/lost opportunity cost has been reflected by double this in market cap losses over the last few years. I would still buy the shares now (and if they get there below seven quid) and put them into the bottom drawer. Good/useful market positions typically eventually get recognised and - especially when the company is relatively lowly indebted - shareholders get a reward. Wake me up at 10 quid a share again.
Filed under: Rolls Royce, Sirius Minerals, Mereo, Tissue Regenix, Woodford, Arena Events, Dignity
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