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Equity Research; Rolls Royce

Rolls Royce FY2016

Conclusion

Rolls Royce has challenges keeping up in its core commercial aerospace market. Some of its product range is a bit dated, with newer products, the Trents 7000, 1000 and 900 and XWB engines all in the cash consuming stage in the engine life cycle. Rolls needs to do better in the high growth widebody aircraft relative to its major competitors (Pratt & Whitney/ Safran). Rolls is targeting 50%+ market share in installed widebody “over the next decade”. This is a good target but Rolls has catching up to do.

There are plenty of moving parts in Rolls, but the 2016 results are to some extent a “kitchen sink” exercise, with plenty of bad news in the knowledge that investors post the bribery scandal are expecting bad news. Still the group free cash flow generation of just £100m is very low (2015 £179m) with virtually all cash generated from operations (£1.41bn) spent in investments (£1.36bn). Underlying EPS fell 49% to 30.13p. This decline could take 2-3 years to recoup.

The board hedged with an outlook statement that affirmed a strong long term outlook but a flat short term outlook. There is no improvement in free cash generation (still £100m for FY17) which is low given £14bn annual revenues. The losses today are due to the realization that profit growth is post 2017.

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