Rolls-Royce issues profit warning

Shares in Rolls-Royce have fallen around 7.8% in trading today following yet another profit warning – the third in less than two years. This latest warning comes as Rolls Royce also announced a suspension of its share buyback program, which is only at the halfway point at this stage. This latest warning is likely connected to the arrival of Warren East as CEO as he clears the decks for the future.

Rolls-Royce cut its earnings target for 2015, with group underlying pre-tax profit now expected to be between £1.33bn and £1.48bn, from a previous range of £1.4bn to £1.55bn. The free cash flow forecast for this year was revised to between a negative £150m and a positive £150m. This compared with previous guidance for positive free cash flow of between £50m and £350m.

Most of the downgrade is on the marine side of the business but at its civil aerospace unit, Rolls Royce’s largest unit by revenue, has been hit by the decision at Airbus to reduce output from ten to six A330 aircraft per month, Rolls-Royce therefore has a slower than imagined delivery stream for its Trent 700 but the numbers remain undiminished.

On the civil aviation side therefore, Rolls Royce is doing very well indeed. The backlog on engines is tremendous, the market leading position for the foreseeable future is assured, but it could be argued that some of those engines are performing slightly better than was imagined by engineers at the outset given that aftermarket revenues are not what Rolls Royce thought they would be at this point – given that Rolls Royce has total control over the aftermarket this is the only logical conclusion.

Many investors wonder why Rolls Royce civil aerospace is lagging behind GE in terms of profit margin by some 5.1%, but this cannot be easily attributed to anything simple such as the fact Rolls Royce is currently moving through a somewhat more intense period of R&D with new engine programs. These market headwinds should be balanced by good growth in widebody aftermarket and a larger-than-expected benefit from the reversal of a balance sheet provision on the Trent 1000 launch, as a result of an expected significant improvement in operating performance, and by improved retrospective TotalCare contract profitability. The value of the provision release and contract profitability are expected together to contribute around £200m, somewhat more than previously expected.

In Civil Aerospace, Rolls Royce expects 2015 underlying revenue and profit within the guided range provided in February of £7,000m to £7,300m and £800m to £900m respectively.