News that the new CEO of Rolls Royce (LON: RR.) called the company a “burning platform” broke on Friday sending the shares down 3% or so. This is a reversal, it’s true, but then RR has near doubled since October. So, what actually is going on here?
The doubling, well, that’s simple enough to explain. The bit of Rolls that we all know about is the jet engines and of course that got hit by the pandemic and lockdown. That led to the £7 billion cash call and that’s going to make the shares less attractive all around for years to come. More capital propping up the same business just does make each piece of capital worth less. Had to be done but still.
Just How Bad Is Rolls Royce’s Strategic Future?
It’s actually worse than many thought though. The big money in jet engines comes not from selling into a new aircraft. That’s done at around cost in fact. It’s the per hour in the air maintenance fees that make the gravy. And, if planes aren’t flying those aren’t arriving. The recovery is therefore obvious – as travel resumes then that cash flow does and there we are.
There are other parts to the company, other turbines for examples, work for the oil and gas industry. The nuclear reactor business might amount to something, maybe, and so on and on. That is, there’s not anything obviously transformative in this near future – no one believes reactors are going to deploy quickly.
Rolls Is in A Dead-End Business
So, here’s the bigger problem with Rolls Royce. Yes, storied engineering giant and all that. But also seemingly in dead end businesses. If the environmentalists get their way jet travel for the masses won’t be allowed soon enough. Only small jets taking environmentalists to important climate change conferences will exist and they don’t use RR engines. That’s being a bit bleak, obviously, but there are those who really do think that way.
We’re hoping that there’s something transformative in there, but no one can really see what it is. Not in the timescales desired at least. What’s worse is that even the mature businesses don’t appear to be run all that well. Yes, sure, great engines and all that. But according to what Tufan Erginbilgic said last week that business wasn’t profitable – properly, in earning its cost of capital – even before the pandemic. That’s not good.
RR. Could Sweat a Dying Business Sector
It’s possible to make terrific profit out of a company whose business sector is dying. Because if the market niche itself is disappearing then there’s no need to invest to keep up with it. All research and even maintenance spending can be slashed. All positive cashflow becomes dividends to be paid to shareholders. But this isn’t really a path that Rolls can follow – that mature business isn’t throwing off those profits. Even if jet engines do die as a sector.
It’s possible to get all depressed at this point. But we should also be appropriately cynical about new CEOs. It’s common enough that the first set of results offer the new guy takes office portray the company as an absolute disaster area. Massive write downs of capital valuations, basically slashing every forecast and starting point for the future. It’s called “kitchensinking”. The aim – if we are cynical – or side effect if we’re just realistic is that then all future results under the new CEO, from this now lowered starting point, look very good.
Do We Believe That Analysis of Rolls Royce?
At which point we’ve got to make a decision about how much of this new CEO’s speech we’re going to believe. “Every investment we make, we destroy value” could be a useful analysis of the corporate situation at RR, it could be some rhetoric from the newly incoming CEO. We each have to apply our own level of belief to that. Some evidence to the general malaise is that most analysts think it generally less profitable than General Electric. Which is not a paragon of efficient profitability itself.
As with so much about investing this is really a matter of beliefs. So, we think that the new CEO is really reading the riot act or just preparing for his reign to look good?
Opinions will vary. For that jet engine business. If this Net Zero idea really does take hold right across the economy, then flying is in difficulty. Rolls Royce knows how to make jet engines and does it very well – but that’s a business sector which will be killed off by that Net Zero. Hey, maybe Rolls Royce should get into the synthetic jet fuel business with Porsche? That would solve the problem right enough.
