Defence Cuts Threaten Rolls-Royce

Rolls-Royce reported 2013 results that reflected solid revenue growth of 27%, but the defense spending environment remains weak, which is a concern for the future

Daniel Holland 14 February, 2014 | 9:47AM

Rolls-Royce (RR.) reported 2013 results that reflected solid revenue growth of 27% (6% excluding the power systems unit). Adjusted profit also improved, though margins were hampered by the inclusion of lower-margin Tognum, resulting in a margin decline of 40 basis points to 11.8%. For 2014, management expects flat revenue growth and profit growth, which would stunt our earnings projections for the company.

The defence spending environment remains weak, which should result in lower potential revenue for Rolls-Royce. We also suspect the company will need to recalibrate its aviation effort after exiting the International Aero Engines joint venture with Pratt & Whitney. We are leaving our fair value estimate unchanged at £10.60 per share as the weak near-term forecast offsets the increase related to the impact of the time value of money on our valuation model. We maintain our narrow economic moat rating.

Rolls-Royce is one of only four firms in the world that can successfully develop and manufacture commercial narrow-body jet engines, a key reason we think the company stands to benefit from sizable competitive advantages in its end markets. That said, we see a few growth headwinds for Rolls-Royce – defence spending is coming under pressure globally and the company lacks a presence in the next generation of commercial narrow-body aircraft.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Rolls-Royce Holdings PLC130.25 GBX-3.45

About Author

Daniel Holland  Daniel Holland is a stock analyst with Morningstar.

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