See the mighty fallen. When I was a boy, Rolls-Royce was a byword for everything that was smart, efficient, faultless and aspirational. British engineering par excellence. A guarantor of quality, and a smooth ride.
Recent months have been horribly bumpy ride for anybody holding shares in Rolls-Royce Holdings (LSE: RR), which have halved in value in the last six months. The stock hasn’t just hit a pothole, it has plunged into a sinkhole, having just issued its fifth profit warning in less than two years. Profits will be towards the bottom of previous guidance, possibly around ÂŁ1.325bn, with chief executive Warren East identifying “headwinds” of around ÂŁ650m next year, which could lead to further downgrades to 2016 forecasts.
Rollercoaster Ride
Falling new orders are bad enough but I am particularly concerned by the slump in its aftermarket as older engines near the end of their working lives. This is often cited as a key reason to invest in Rolls-Royce, as it all but guarantees a secure long-term income stream. Weakening demand for Trent 700 engines and a slump in its marine division due to falling demand from offshore oil companies shows that Rolls-Royce is facing problems across the board.
Rolls-Royce still boasts a huge order book and that will tempt some to chance a ride at today’s lowly valuation of 7.86 times earnings. Be warned, it may yield 4.36% today but there is a fair chance the dividend will be cut. The stock is a car crash and it will take some time to clean up the mess.
Stormy Weather
BAE Systems (LSE: BA) looks a steady investment by comparison. In the last six months, its share price has fallen “just” 10%. But there are storm clouds gathering. BAE has just announced that it will cut 371 jobs following a slowdown in production of its Typhoon fighter jet, after a delayed new order from Saudi Arabia. This will cut sales revenue from around £1.3bn in 2015 to approximately ÂŁ1.1bn in 2016.
Markets had expected worse, however, and largely shrugged off problems in Australia where BAE’s Williamstown shipyard has no new work, leading to more layoffs. Investors seem willing to accept chief executive Ian King’s view that “good sales growth in 2015 and a robust order backlog at the half year of ÂŁ37.3bn underpins confidence in the future prospects for the business”.
On The Defensive
Defence should be a good industry to be in right now, given today’s mounting terror threat. NATO members are likely to find it hard to justify further cuts in military spending, while Middle Eastern customers such as Saudi Arabia and Kuwait are likely to carry on spending. Trading at 11.9 times earnings and yielding 4.5%, covered 1.9 times, BAE’s numbers look decent as well. As does its robust order backlog, currently £37.3bn.
Rolls-Royce has a healthy order book as well, but that doesn’t appear to have spared it, so nothing can be taken for granted. BAE Systems looks in a relatively stronger position, but these are volatile times.