After hitting the headlines with its 2016 results last month, troubled aerospace and engineering group Rolls-Royce (LSE: RR) seemed to divide opinion on whether the company had indeed turned a corner, or whether it was still too early to see a positive impact from its transformation programme. City analysts will no doubt agree to disagree about the group’s prospects, but what does this Fool think?
Huge loss
Last month the FTSE 100 engine maker made the news when it reported a massive £4.6bn pre-tax loss, blamed on the fall in the value of the pound and a corruption settlement relating to historical bribery allegations. The huge pre-tax loss, which was one of the biggest in corporate history, masked an improvement in the company’s underlying performance, which many believe could signal the start of new era for Rolls-Royce.
Total revenues for the group were up 9% to £15bn on a reported basis, but down 2% to £13.8bn on an underlying basis, reflecting weakness in the marine market, due to the oil-price slump. Underlying pre-tax profits crashed 49% to £813m, compared to £1,432m in 2015. But this was much better than the £685m consensus forecast.
Transformation programme
During the latter part of 2015 the company announced a major transformation programme focused on simplifying the organisation, streamlining senior management, reducing fixed costs and adding greater pace and accountability to decision making. To its credit, management has made a better-than-expected start to delivering its objectives, with savings achieved during 2016 coming in above their initial target of £30m–£50m, at £60m.
During the course of the year the group also identified significant opportunities to drive sustainable cost savings from the business. As a result, savings of £80m–£110m are expected to be delivered in the current year. In total, expected ongoing benefits of all current restructuring programmes initiated over the past three years should reduce costs by around £400m by the end of 2018.
Premium valuation
I believe Rolls-Royce is beginning to turn the corner, with the new CEO taking a pro-active approach to restructuring and reducing costs, as well as aiming to improve business conduct and stamp out bribery and corruption within the organisation. The group is expected to return to profit this year, with City forecasts suggesting a pre-tax profit of £867m, followed by an even better £1.1bn pre-tax profit in 2018. Analysts are also expecting an improvement in underlying earnings for the first time since 2013, with 6% growth expected this year and a 20% increase forecast for the year to December 2018.
So, all-in-all, I think the future looks much brighter for Rolls-Royce, but I still don’t believe it makes for an attractive investment at the present time. Sadly, a premium P/E rating of 24 means the shares are trading well above historical levels, and I believe keen investors should continue to be patient and wait for a better entry point.