RR - Rolls-Royce

[Spekulatius]

I sold my small position yesterday. I never got comfortable enough to make this a half position and should have sold years ago. I can't see a clear risk/reward now. Global air traffic should rebound in the next 18-24 months. But many of their customers may go bankrupt.

 

Sold as well today. I agree with your assessment, it’s too operationally leveraged. The service contracts get paid by flight hours and engine deliveries may be on hold. I think the stock to buy is Airbus, when this clears up a little.

[Castanza]

I sold my small position yesterday. I never got comfortable enough to make this a half position and should have sold years ago. I can't see a clear risk/reward now. Global air traffic should rebound in the next 18-24 months. But many of their customers may go bankrupt.

 

Sold as well today. I agree with your assessment, it’s too operationally leveraged. The service contracts get paid by flight hours and engine deliveries may be on hold. I think the stock to buy is Airbus, when this clears up a little.

 

I wonder how lenient Airbus will be with deliveries. I can picture a few airlines hoping to hold that ship at sea.

[Spekulatius]

I sold my small position yesterday. I never got comfortable enough to make this a half position and should have sold years ago. I can't see a clear risk/reward now. Global air traffic should rebound in the next 18-24 months. But many of their customers may go bankrupt.

 

Sold as well today. I agree with your assessment, it’s too operationally leveraged. The service contracts get paid by flight hours and engine deliveries may be on hold. I think the stock to buy is Airbus, when this clears up a little.

 

I wonder how lenient Airbus will be with deliveries. I can picture a few airlines hoping to hold that ship at sea.

 

Yes, Airbus will be flexible. I can see that the 737 is tainted and airlines may not want it, even if the business picks up again and they again need planes. LUV in the longer term has a huge issue be sure they are a single aircraft (737) airline and the 737 max was their upgrade path. They are no so big, that they probably need to start buying from Airbus to diversify their risk.

[Xerxes]

Agreed

Ironically the one airline that had an all 737 Boeing fleet will likely be diversifying with Airbus (and most likely A220 given that the larger NEOs are sold off for years), the very same plane that they (Boeing) tried to wack when it used to be called C Series and ran it into the arms of Airbus for $1. 

[Xerxes]

I sold my small position yesterday. I never got comfortable enough to make this a half position and should have sold years ago. I can't see a clear risk/reward now. Global air traffic should rebound in the next 18-24 months. But many of their customers may go bankrupt.

 

Sold as well today. I agree with your assessment, it’s too operationally leveraged. The service contracts get paid by flight hours and engine deliveries may be on hold. I think the stock to buy is Airbus, when this clears up a little.

 

Congrats to both of you for selling. it is now 3$ or so. :-)

I kept mine; although was against it. it was such a small bet for me and now it is even smaller.

I ll just leave it there.

 

 

[Xerxes]

Dividend suspended.

 

This thing cannot survive on its own with its portfolio centered on wide body program and business jets. With wide body being in structural decline ...

 

And cannot be merged with GE due to anti trust reasons.

 

[KCLarkin]

Dividend suspended.

 

This thing cannot survive on its own with its portfolio centered on wide body program and business jets. With wide body being in structural decline ...

 

And cannot be merged with GE due to anti trust reasons.

 

Hmm. The press release seemed bullish to me.

[ukvalueinvestment]

Dividend suspended.

 

This thing cannot survive on its own with its portfolio centered on wide body program and business jets. With wide body being in structural decline ...

 

And cannot be merged with GE due to anti trust reasons.

 

Hmm. The press release seemed bullish to me.

 

"structural decline" appears a very pessimistic way of putting it.  RR is part of a duopoly in the wide body market and there are maintenance based cashflows coming in for the next 20 years.  In addition, why would they want to merge with GE, who have their own set of issues?

[Xerxes]

sorry I should have not merged my own views with the press release.

 

I am not saying the company is going out of business. What I am saying is that in world were the narrow-body A.321 XLR is eating more and more into the middle of market segment, long term there is less demand for wide body aircraft (i.e. structural decline). This view is on the whole market not related to RR specifically, however given that RR has an outsized position in the wide body in its product portfolio as oppose to narrow body it will impact them much more than GE or P&W, both of which are part of greater businesses, and RR is not.

 

RR left the most lucrative part of the market (i.e. narrow body) years ago when it sold its stake in the JV back to P&W.

 

On the aircraft side, Boeing tried to do the impossible: to come up with a wide-body aircraft but with low economics of a narrow-body, to bridge the middle of market segment. There was never much confidence on that and now with new leadership in charge they are likely to work on shoring up their financials and fix their current issues.

 

I own both RTX and RR; but rather add to my RTX than add to RR.

 

 

[Spekulatius]

I sold this because I realized that RR may get into a cash squeeze. Their cash flows have been weak all along and their maintenance contracts are based on flying hours, which I am guessing went to near zero.

 

RR will not go bankruptcy. It is an strategic assets for the UK and the government own a golden share and will backstop them. I don’t think a backstop in Europe will be as painless than in the US. Governments in Europe do not shy away from taking control of a business. In the UK’ case, the most likely case is a capital raise that is backstopped by the government and will hand them effective control. It has happened before many decades (1970’s ?) ago , so it’s not without precedent at all

[Spekulatius]

So, here we are - RR.L credit rating cut to junk (by 2 notches) to BB. Since they make their living on LT service do facts, that’s not going down well with customers. They probably will get some backstop from the UK government,  but there is no way to tell what it is going to cost for equity holders (UK holds a golden share in RR).

 

Europe isn’t like the US as far as bailouts are concerned, and bailouts often wipe out or impair equity.

https://www.reuters.com/article/us-health-coronavirus-rolls-royce-hldg/sp-cuts-rolls-royce-credit-rating-to-junk-on-covid-19-hit-idUSKBN2343DB

[TheAiGuy]

So, here we are - RR.L credit rating cut to junk (by 2 notches) to BB. Since they make their living on LT service do facts, that’s not going down well with customers. They probably will get some backstop from the UK government,  but there is no way to tell what it is going to cost for equity holders (UK holds a golden share in RR).

 

Europe isn’t like the US as far as bailouts are concerned, and bailouts often wipe out or impair equity.

https://www.reuters.com/article/us-health-coronavirus-rolls-royce-hldg/sp-cuts-rolls-royce-credit-rating-to-junk-on-covid-19-hit-idUSKBN2343DB

 

Yeah, so, aren’t all of their customers on the brink of failure?  What do we think the long-term survivability of GE is, say if American Airlines folds?

 

Normally, I would agree with you that the credit quality of RR really matters to it’s long term business prospects for the reason you state. But all of these companies are very close to bankruptcy, so I have a hard time seeing how RR’s credit rating, specifically, will impact its competitive position in the context of the pandemic.

 

 

[sleepydragon]

especially RR focus on making engines for wide body airlines -- long distance, a lot of passengers, low fuel consumption.. I imagine nobody order those airlines now.

[ValuePadawan]

So, here we are - RR.L credit rating cut to junk (by 2 notches) to BB. Since they make their living on LT service do facts, that’s not going down well with customers. They probably will get some backstop from the UK government,  but there is no way to tell what it is going to cost for equity holders (UK holds a golden share in RR).

 

Europe isn’t like the US as far as bailouts are concerned, and bailouts often wipe out or impair equity.

https://www.reuters.com/article/us-health-coronavirus-rolls-royce-hldg/sp-cuts-rolls-royce-credit-rating-to-junk-on-covid-19-hit-idUSKBN2343DB

 

Hi Spek do you have a view on whether the power systems and defense segments will be able to keep Rolls afloat long enough for air travel to come back?

[Xerxes]

Folks, invest with consolidator … Raytheon Technologies not Rolls Royce.

Notwithstanding golden shares and such, Rolls Royce, a $10 billion business, with huge exposure in wide body MRO and business jet, would need scale to compete. It will get bought it. Golden shares didn't stop Rolls Royce Motor to go with BMW several decades ago.

 

Contrast that with Raytheon Technologies, a $100 billion business.

GE is nowhere close, not because of GE Aviation, but everything else that had gone wrong.

 

Unless, you are buying RR on the hope of it being acquired, Raytheon Technologies is the consolidator to go with.

its defense assets will catch the tailwind of hypersonic R&D, P&W will suffer short term but has the right mix and will be the consolidator and already has a hefty exposure to Pentagon (i.e. F135 engines), Collins Aerospace fiefdom is pretty diversified between Airbus and Boeing offerings.

 

Raytheon Technologies may have an income statement problem (like the rest of the industry), but it does not have balance sheet problem (like Boeing, GE or RR). In times like this, if you cannot expand your balance sheet to take advantage of the opportunities that means the company is not run by good capital allocator.

 

In case of RR, this is not Warren East' fault, and in case of GE, this is not Larry Culp's fault, both guys were dealt a bad hand.

Both businesses will survive but will not dominate.

[rb]

Folks, invest with consolidator … Raytheon Technologies not Rolls Royce.

Notwithstanding golden shares and such, Rolls Royce, a $10 billion business, with huge exposure in wide body MRO and business jet, would need scale to compete. It will get bought it. Golden shares didn't stop Rolls Royce Motor to go with BMW several decades ago.

 

Contrast that with Raytheon Technologies, a $100 billion business.

GE is nowhere close, not because of GE Aviation, but everything else that had gone wrong.

 

Unless, you are buying RR on the hope of it being acquired, Raytheon Technologies is the consolidator to go with.

its defense assets will catch the tailwind of hypersonic R&D, P&W will suffer short term but has the right mix and will be the consolidator and already has a hefty exposure to Pentagon (i.e. F135 engines), Collins Aerospace fiefdom is pretty diversified between Airbus and Boeing offerings.

 

Raytheon Technologies may have an income statement problem (like the rest of the industry), but it does not have balance sheet problem (like Boeing, GE or RR). In times like this, if you cannot expand your balance sheet to take advantage of the opportunities that means the company is not run by good capital allocator.

 

In case of RR, this is not Warren East' fault, and in case of GE, this is not Larry Culp's fault, both guys were dealt a bad hand.

Both businesses will survive but will not dominate.

Well the thing is that a lot of people in commercial aerospace are buying Pratt engines. So that sucks.

 

Rolls may be ok in a horrible, relative way if they don't go bk. They loose money on new engines but the spare parts business is highly profitable. So the mix will go higher margin with the new planes getting pushed back. It's not a lot but it's something.

 

If you're looking for alternatives I think that the best shop in the business is Safran. They have 1/2 of the GE narrow body business and a bunch of military/security stuff. They're nowhere close to overlevered either. While they stock price came down a lot, it's not what I would describe as cheap. But then neither is Raytheon or whatever is classed these days.

[Xerxes]

All engine manufacturers have more or less the same model.

Sell engines at or near cost, to plant the seeds, get the MRO stream for the life of the program.

 

This is not unique to RR.

 

Aircraft manufacturers though are typically different. Cash comes at delivery of the aircraft.

that is why Airbus and Boeing are so susceptible to production rate decrease and the cash flow gets hammered.

 

Engine manufactures still have a broad diversified revenue stream from all their platforms currently in operation even if their production rate gets hammered.

The only thing that can throw a monkey wrench into that model, is a black swan event that makes majority of aircraft being grounded cutting off the high margin cash flow from MRO. But I reckon going from a 95% aircraft grounded to 70% grounded is relatively fast, going from 70% to 45% will be slower, and lastly going from 45% to close to zero (or Dec 2019 level), will take years. So the A/M juice will start to flow again lifting the boats, but not at the same rate, with regional and narrow body first and lastly wide body.

[rb]

Yeah, but rolls was having some cash questions because their programs were pretty aggressive with deliveries (which were cash negative). Now that new deliveries dropped off the face of the map that helps. Yea the planes will fly less and that also squeezes the cash cow that is aftermarket. But I wasn't breaking out the champagne. It's just a silver lining because Rolls was the most commercial engine manufacturer exposed to new deliveries.

 

[Spekulatius]

Rolls Royce will survive, but if current equity owners benefit is another question. About 50% of their business is commercial aerospace engines, but if you count the ITP business, the dependency to commercial aerospace growth to ~60%. Then we have the power business, which isn’t exactly thriving either.

 

When I put my smallish bet on RR, I thought that this business needs to keep an investment grade credit rating, just because of the huge amount of liabilities and assets resulting from the long tail nature of their business (service contracts, hedges etc ). They have -3GBP of equity and a ~35GBP of assets which is a pretty large balance sheet for a company of RR size. if the counterparties get nervous, they need to recapitalize, no way around that and that could mean partial nationalization. Hard to handicap, so I decided to get out when I saw this coming.

 

What really is going to happen is anyone’s guess, but they have challenges abound.

[ValuePadawan]

Rolls Royce will survive, but if current equity owners benefit is another question. About 50% of their business is commercial aerospace engines, but if you count the ITP business, the dependency to commercial aerospace growth to ~60%. Then we have the power business, which isn’t exactly thriving either.

 

When I put my smallish bet on RR, I thought that this business needs to keep an investment grade credit rating, just because of the huge amount of liabilities and assets resulting from the long tail nature of their business (service contracts, hedges etc ). They have -3GBP of equity and a ~35GBP of assets which is a pretty large balance sheet for a company of RR size. if the counterparties get nervous, they need to recapitalize, no way around that and that could mean partial nationalization. Hard to handicap, so I decided to get out when I saw this coming.

 

What really is going to happen is anyone’s guess, but they have challenges abound.

 

Thanks Spek I appreciate you sharing your point of view! Do you have a view on if it will make a difference if the Bank of England starts buying corporate bonds? I've noticed GE's credit default spreads have held up much better than RR's I'm attributing that to the Fed's buying of corporate bonds. Do you think I am missing anything?

 

https://www.assetmacro.com/united-states/credit-default-swaps-cds/ge-capital-credit-default-swaps-ge-5y-cds/

https://www.assetmacro.com/united-kingdom/credit-default-swaps-cds/rolls-royce-credit-default-swaps-rolls-5y-cds/

[Sunrider]

Rolls Royce will survive, but if current equity owners benefit is another question. About 50% of their business is commercial aerospace engines, but if you count the ITP business, the dependency to commercial aerospace growth to ~60%. Then we have the power business, which isn’t exactly thriving either.

 

When I put my smallish bet on RR, I thought that this business needs to keep an investment grade credit rating, just because of the huge amount of liabilities and assets resulting from the long tail nature of their business (service contracts, hedges etc ). They have -3GBP of equity and a ~35GBP of assets which is a pretty large balance sheet for a company of RR size. if the counterparties get nervous, they need to recapitalize, no way around that and that could mean partial nationalization. Hard to handicap, so I decided to get out when I saw this coming.

 

What really is going to happen is anyone’s guess, but they have challenges abound.

 

I believe they stated in a recent release that none of their facilities (including their hedge book) has any clauses tied to their credit rating ... so on that basis your concern should be addressed? As to the impact of the dramatically lower flying hours ... of course that's a guess when things will revert, though the loss of sales this year should help a bit as they sell engines at an upfront loss.

[starmitt]

This is probably a negative two cents, but this discussion seems very centered on roughly 35% of their business - see https://www.rolls-royce.com/~/media/Files/R/Rolls-Royce/documents/annual-report/2019/2019-full-annual-report.pdf (civil aerospace looks to be about 50% of revs, with large aircraft engines 71% of that). On initial impression the other lines of business should be much less impacted. Sorry, not deep on this yet.

 

Two other thoughts on that 35%. No idea whether this is current or to what extent, but https://theaircurrent.com/airlines/confusion-among-u-s-airlines-as-airplanes-fly-empty-to-get-bailout-funds/ suggests service revenues might not be as badly impacted as imagined. Still I would be inclined to model the worst case short term, but recognize govts everywhere can complicate things.

 

Longer term - going out a couple years - if RR survives, consider this: https://pbs.twimg.com/media/EVU3t4KXkAES7IG?format=png&name=900x900

 

 

 

[Broeb22]

https://www.equities.com/news/rolls-royce-plans-1-5-billion-equity-raise-to-plug-capital-shortfall

 

Anyone more knowledgeable than I know what this equity raise would do equity holders / potential upside?

 

I wonder what the widebody market looks like post-COVID. It seems like short-term narrow body will get more service and plane sales than widebody. In 3-5 years, widebody is probably back to pre-COVID. What will it take for Rolls to get there and what will be left for equity holders?

[Broeb22]

https://seekingalpha.com/article/4356237-capital-interviews-steven-wood-of-greenwood-investors-discusses-investment-process-and-how-to

 

Steven Wood, who has done a lot of work on the company, shared some thoughts on Rolls.

 

I bought this years ago after Steven shared his research with my prior firm. The guy does meticulous work; there's no doubt about that.

 

But he's a guy who seems to be in the "precisely wrong" camp as opposed to approximately right a lot on this idea (and other investments).

 

I remember in 2016 when we first purchased it that free cash flow was going to inflect higher in 2 years, and I don't know that it has (or will now that COVID may be here a while).

[Spekulatius]

https://www.equities.com/news/rolls-royce-plans-1-5-billion-equity-raise-to-plug-capital-shortfall

 

Anyone more knowledgeable than I know what this equity raise would do equity holders / potential upside?

 

I wonder what the widebody market looks like post-COVID. It seems like short-term narrow body will get more service and plane sales than widebody. In 3-5 years, widebody is probably back to pre-COVID. What will it take for Rolls to get there and what will be left for equity holders?

 

Well a reasonable approach is to look at the 1.5GBP relative to their current market cap (~4.9GBP). Assuming a discount and call it 4.5GBP, we are looking at a ~30% increase in sharecount.