Rolls-Royce issues third profit warning

Shares in turbine maker Rolls-Royce fell by almost 10% this morning after the company issued its third profit warning in little over a year and stopped its earnings enhancing share buyback.

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  1. Garry White

The old City adage is that profit warnings tend to come in threes. When management was asked on this morning’s conference call whether this warning will be the last, it could not offer any guarantees.

Rolls-Royce is now another victim of the oil-price crash. The company makes technologically complex propulsion systems for offshore oil and gas vessels and the weak oil price environment has hit orders at its marine division. It also cited soft demand for some of its older aircraft engines.

It is not a coincidence that the warning came three days after the new chief executive, Warren East, got his feet under the desk. It is a familiar pattern of “kitchen sinking” where all the bad news is issued at the start of a chief executive’s tenure. This gives the new head a clean sheet in which to rebuild a business.

Rolls-Royce warned that continuing weakness in offshore oil markets would lower profit in its marine division by around £85m in both 2015 and 2016. Revenue guidance for 2015 is unchanged but the company now expects pre-tax will to be between £1.3bn and £1.47bn, down from a previous estimate of £1.4bn to £1.55bn.

The company’s £1bn share buyback was halted half way through because new guidance on free cash flow means that it could actually be negative. The guidance was revised to between a negative £150m and a positive £150m, compared with previous guidance of between £50m and £350m.

The marine division was the reason for the group’s previous profit warning in February. Last month Rolls-Royce revealed it would cut a tenth of its 6,000-strong marine division workforce. However, there are other issues at play too.

There is also what the company referred to as “net headwinds” of £300m in its civil aerospace operation in 2016. The jet engine unit, which generates the lion’s share of the company’s revenue, has been hit by an engine transition on the Airbus A330 wide body airliner. There has also been weaker-than-expected demand for engines in business jets.

The further warning related to the marine division is arguably not that surprising. The warning relating to civil aerospace is more so. There is a lower-than-expected demand for its Trent 700 engines and pricing pressure is also an issue at the unit.

The City had hoped that the appointment of Mr East would lead to confidence being restored in the company after a series of clumsy warnings in 2014. It now appears that the company’s issues are going to continue to rumble on into 2016.

Unfortunately, today’s warning has further damaged investor confidence surrounding the company and Mr East will have to prove that he has a grip on his business. Cash management has been an issue for investors for some time, so the cancellation of the buyback is also a big concern.  Another worry is the fact that about 70% of total profits this year have to be earning in the second half.

Rolls-Royce will provide its next update the market on July 30, when it is scheduled to release its interim results. There needs to be a real focus on rebuilding investor confidence, as this is the biggest challenges facing Mr East. Today’s news is a major setback on this front.

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