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Rolls-Royce Reports Record Loss In 2016

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Rolls-Royce Reports Record Loss In 2016

Rolls-Royce Reports Record Loss In 2016
February 20
08:59 2017

LONDON — When a company reports one of the largest annual losses in its country’s history, you would expect that the knives would be out for its management.

However, despite UK engine-maker Rolls-Royce turning in a whacking £4.6 billion ($5.7 billion) pre-tax loss for 2016, the general reaction of shareholders and commentators was a sigh of relief.

Why? Because they expected it to be even worse.

Admittedly, around £4.4 billion of that huge loss was on paper only, the result of some major currency hedging maneuvers going sour. Most of the company’s costs are in sterling, but the international aerospace market operates in dollars. Companies with large overseas sales such as Rolls-Royce bet on the future movements of currencies in an attempt to smooth out what they foresee as likely volatility in the currency markets, months, or even years down the line.

At the time most of the company’s hedging positions were taken, the dollar was expected to fall in international currency markets.

But that was before the UK unexpectedly voted in June 2016 to leave the European Union, a decision that has since seen the British currency lose almost 20% of its value against the greenback.

A further unexpected loss came in January 2017 when the company agreed to pay the UK, US and Brazilian governments £671 million to settle several cases of corruption in sales to Indonesia, China, Russia and Thailand stretching back more than 20 years. A hefty price, but one that spared the company being dragged through the courts with the inevitable months of bad publicity.

If you strip out these ‘one-off’ events, the Rolls-Royce Group made an underlying pre-tax profit of £813 million (down 49% on 2015) on revenue of £13.8 billion (down 2%).

Part of the problem for Rolls-Royce is that it is much more than an airliner engine manufacturer; its marine and industrial power divisions have been a drag on the Group for several years, with poor performance depressing the overall figures. There has been talk of selling off those divisions for several years, but no developments on this front have yet materialized.

Zeroing in on the civil aerospace division, however, profits still dipped sharply – by 60% in fact – to £367 million on revenues that were flat at £7.1 billion. But they were still better than observers had been anticipating – hence more sighs of relief.

Why the sharp fall? Like companies from photocopier manufacturers to garages, Rolls-Royce’s civil engine division makes its money not so much from the sale of new engines – important though that is – but by the long-term provision of care and maintenance services for those engines already in service.  That brings in a steady stream of income for years after the initial sale.

The company is in the middle of a transition period from servicing older engines that require steady maintenance to a new generation of Trent engines – the sole powerplant on the Airbus A350, for example – that is rapidly entering service but does not yet need that after-care.

On the plus side of the equation, production of the new models of Trent are ramping up. The latest version, the Trent 1000 TEN, received ASA certification last year and development of the new Ultrafan gearbox is progressing well.  The earlier Trent 800 also has a 40% market share on those Boeing 777 models for which it is available.

The company has a healthy orderbook worth £4.4 billion, its supply chain is being modernized and costs are being reduced. New chief executive Warren East is also cutting layers of management out of the organization to make it more efficient.

However, as Saj Ahmad, chief analyst at UK consultancy Strategic Aero Research points out, Rolls-Royce no longer has an engine in the narrowbody section of the market, which is where the bulk of aircraft manufacturers’ backlogs now lie. Thousands of Airbus A320neo-family and Boeing 737 MAX aircraft will take to the skies with General Electric or Pratt & Whitney engines.

“After selling its stake in International Aero Engines [which has powerplants on some A320-family aircraft] to Pratt & Whitney, Rolls-Royce doesn’t even have revenue from that coming in – how can anyone in their right mind think that this is a strategy that is cohesive when you are out of the most high-volume market with 737s and A320s?” queried Ahmad.

For 2017, East predicted a modest improvement in performance in sales and profits, even after the high costs involved in ramping up engine production.

Ahmad has some concerns on that: “Their growth is something I doubt. With Airbus struggling to ramp up A350 rates, deliveries falling on the A330 and A380, just where is RR thinking it will get its growth from? It is second fiddle to GE on the 787 as well.

“RR can go on blaming currency exchange and other factors, but the reality is that it has aligned itself, bar the Boeing 787 and Airbus A350, on niche, poor-selling airplanes like the A330neo and the A380 – and it has even struggled to make money on the Trent 700 powering the A330.”

The financial markets will doubtless be watching East’s prediction of modest growth in 2017 closely.

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About Author

Alan Dron

Alan Dron

Old-school scribe who now is fortunate enough to earn a fair percentage of his income by writing about aviation. Still laments the passing of Concorde and has been known to take a day trip to the Middle East to interview an airline executive.

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