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Engineer looks like it may be back to winning ways after years of turmoil
Thursday 22 Jun 2017 Author: David Stevenson

Aerospace and defence giant Roll Royce (RR.) is motoring again after a string of profit warnings starting in 2014.

Its shares are up 50% in 12 months, hitting 909p. Yet, as the world moves out of austerity making an increase in global spend likely, Rolls may have further to run.


Flying time

The company’s statement on 16 June says its businesses are performing in line with expectations and a recent broker note describes visiting some of the company’s sites and coming away impressed. Celine Fornaro, analyst at UBS, says she ‘could fully appreciate some of the cultural changes and shifts within the organisation in terms of manufacturing, supply chain and costs’.

This bodes well for Rolls. A focus on increased production as well as more efficient operations could well have a positive effect on profit margins and aid its bottom line going forward. The company operates in a number of fields but its central activity is the design and manufacture of engines for planes.

UBS reports the use of Rolls Royce powered Boeing 787s has picked up substantially. The company also builds the engines for the European Airbus A350 which the latest available data from April shows an average flying time of 12.9 hours a day, more than the levels achieved by 787s. These numbers confirm for UBS’s Fornaro that the A350 could be a key driver for the company’s future cash generation and profit.

What are the downsides?

Rami Myerson, an analyst at Investec, is not a fan of Rolls, recommending to sell back in May with a bearish price target of 575p. The argument is that Rolls will get itself into trouble if it signs a deal with Boeing to produce engines for mid-size planes, dubbed the 797.

Myerson says if Rolls is selected to build the engine, it could be a ‘material headwind’ for the company’s goal of delivering £1bn in free cash flow by 2020. This is due to expected development costs of over $10bn, with a return on investment only evident by the 2030s at the earliest according to the analyst.

Ultimately we like Rolls Royce as we believe the company is now being well run by Warren East, who became chief executive in 2015 and drove through major restructuring including thousands of job cuts.

Buy at 909p

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