RR - Rolls-Royce

[ValuePadawan]

Wow I thoroughly enjoyed the writeup thanks!

[Spekulatius]

Wow I thoroughly enjoyed the writeup thanks!

 

I second this. I do find it strange that  nobody mentions the doomsday scenario:

 

1) continued weak cash flows cause a credit downgrade to near junk

2) due to customers getting uneasy about RR.L meeting their LT obligation after above, RR decides to do a deeply discounted rights offering

That would cause dilution at the bottom (foreign ADR holders for sure couldn’t participate and would get screwed) and permanent loss of capital.

[Spekulatius]

Valueact leaving the board - shares down 3%+.

https://finance.yahoo.com/news/1-rolls-royce-says-valueact-084809104.html

 

Probably got tired waiting for the turnaround after 4 years and do some housecleaning for next year. They own a substantial position, so if they sell, it could put further pressure on the stock.

[ValuePadawan]

I wonder what they are seeing at the board level that is making them wave the white flag. With XWB starting to hit the maintenance schedule I'm expecting cash flows to increase and if they can cut costs and reduce headcount by the end of 202o like they are saying they will it seems like odd timing to say the least.

[buffetteer1984]

Could be tax loss selling for valueact.  It's interesting that they would be doing this as the stock is near a low very similar to their investment in ADS.

[ValuePadawan]

Ya it could be. There are many reasons to sell but only one to buy.

[Spekulatius]

The stock has trended down (after the Valueact representative left the board and they presumable started to sell down their position) and I have added a bit to my position,  it don’t have the cojones to make this a major bet. they will announce their 2019 results on February 28 and so far every earnings announcement has been an disappointment. I am particularly concerned about the FCF numbers , as those were very weak for the half year results and I think rating agencies have them under the microscope.

 

Then there is concern about further deterioration of the Trent 1000 and of course any news with problem with the Trent XWB engine (their largest program) would be a killer.

 

That said, this trades at 0.8x revenues and if they can turn this around, it should beantworte  at least 2x the still growing revenues at some point. So I think we are looking st least at a 2 bagger plus organic growth if they turn this around. Also the Boeing woes are a tailwind for RR, since they are sole supplier for the A350 and their largest product. The A350 is the main competitor to Boeing’s 737 max and I expect it will do very well.

[KCLarkin]

A350 is competitor to 787 not 737. RR only sells wide body engines.

[ValuePadawan]

Spekulatius I too will be watching the cash flow numbers closely in addition to keeping an eye on whether they are making their numbers in terms of headcount and restructuring as well as reducing R&D spend and if their inventory starts to come down back to regular levels now that the Brexit path is more certain.

 

 

As a bit of a tangent I was reading they are looking into the hybridization of widebody engines by the 2030's or so.

 

This seems crazy to me based on current battery technologies.

 

The batteries in a Tesla have an energy density of around 240 Wh/kg. The batteries that are being researched right now might have an energy density of 280-300 Wh/kg.

 

Kerosene has an energy density of around 14,000 Wh/Kg.

 

Even if jet engines are only 35-40% efficient in terms of kinetic energy Fig. 3.2(https://www.nap.edu/read/23490/chapter/6#37) and somehow electric jet engines somehow get to double that efficiency as they have with automobiles.

 

They would still need more than 20kg of batteries to replace 1 kg of kerosene. This doesn't even get into the cost of the batteries or their lifespan it just doesn't seem technically feasible to electrify or even hybridize aviation at all in the next decade.

 

Does anyone know why Rolls are pursuing hybridization? Is it for the PR to keep environmentalists satisfied or am I making a mistake and missing a crucial piece of the electronic aviation puzzle?

[Spekulatius]

Spekulatius I too will be watching the cash flow numbers closely in addition to keeping an eye on whether they are making their numbers in terms of headcount and restructuring as well as reducing R&D spend and if their inventory starts to come down back to regular levels now that the Brexit path is more certain.

 

 

As a bit of a tangent I was reading they are looking into the hybridization of widebody engines by the 2030's or so.

 

This seems crazy to me based on current battery technologies.

 

The batteries in a Tesla have an energy density of around 240 Wh/kg. The batteries that are being researched right now might have an energy density of 280-300 Wh/kg.

 

Kerosene has an energy density of around 14,000 Wh/Kg.

 

Even if jet engines are only 35-40% efficient in terms of kinetic energy Fig. 3.2(https://www.nap.edu/read/23490/chapter/6#37) and somehow electric jet engines somehow get to double that efficiency as they have with automobiles.

 

They would still need more than 20kg of batteries to replace 1 kg of kerosene. This doesn't even get into the cost of the batteries or their lifespan it just doesn't seem technically feasible to electrify or even hybridize aviation at all in the next decade.

 

Does anyone know why Rolls are pursuing hybridization? Is it for the PR to keep environmentalists satisfied or am I making a mistake and missing a crucial piece of the electronic aviation puzzle?

 

I think part of the answer for the battery may be that that peak power is only needed during takeoff or in emergencies, so maybe not much stored energy is needed if a hybrid tech is used. Otherwise it’s correct that the power density of batteries is way too low to completely replace kerosene powered jet engines.

 

Kclarkin is correct that the A350 is a competitor to the larger 787 and not the 737 max. In any case, they are not affected by the 737 max disaster, unlike GE potentially.

[SharperDingaan]

You might want to ask yourself WHY you are willing to take on the ongoing turn-around risk AS WELL AS the disruption, from the coming Brexit. Most would be looking at a temporary exit until after the dust settles.

 

SD

[Xerxes]

Great discussion folks:

 

i ll just throw in few qualitative points for the sake of discussion:

 

Aside the development issues RR has had, there has been a few strategic headwinds in recent years. (1) They lost the business jet position with Gulfstream to P&WC early in the decade, (2) they sold their stake in IAE to P&W and effectively removed themselves from the narrow body segment, which is now the absolute place to be (3) they got impacted by Bombardier drop in Global production rate on the legacy aircraft (4) there has been softness in the wide-body market and that is looking like more and more a permanent structural change.

 

On (1) & (3), RR has been working hard to get back into the game (i.e. note the brand new Gulfstream G700 + Global 5500/6500); on (2) P&W and CFM are well trenched in for the long haul; On (4) the wide-body softness looks more and more like a structural change. With the introduction of the likes of Airbus A.321LR, the upper segment of that narrow-body category is making the lower end of wide-body very vulnerable. (dont believe Boeing MOM will happen either) On a positive side, RR has A.350 and A.330NEO to itself.

 

Consolidation:

 

I believe in the long term RR needs scale. Note that Honeywell, future Raytheon Technologies and GE all have market capitalization north of $100B whereas Rolls Royce has a market cap of ~$13B. I cannot believe that with all the consolidation happening in the A&D sector, RR will not be participating as a target.

 

I dont believe Raytheon Technologies will be a buyer given where they are now with Raytheon about to be folded in (that said P&W is very complementary to RR from a product segment point of view); it would definitely not be GE (given their financial troubles and more importantly a GE-RR tie-up would mean a virtual monopoly in the wide-body segment). That leaves Honeywell or other PE-like shop as potential buyers.

 

 

 

 

 

 

[Jurgis]

That leaves Honeywell or other PE-like shop as potential buyers.

 

Berkshire.  ;)

[Spekulatius]

I don’t think Brexit is a huge risk, as it is in both the EU (Airbus) and the UK‘s interest to keep the supply chain intact.

 

As for getting acquired, one has to consider that RR is a strategic asset for Britain and the government has a veto in important matters via a golden share. So, I don’t think that an acquisition by PE is in the cards.

 

My big concern is that in the case RR‘s future looks financially shaky, the government is going to facilitate a capital raise and doing what’s best for the UK, shareholder value be damned.

[ValuePadawan]

My big concern is that in the case RR‘s future looks financially shaky, the government is going to facilitate a capital raise and doing what’s best for the UK, shareholder value be damned.

 

What would cause such a shaky financial future? The only thing I can think of is massive problems with the Trent XWB engine and so far as I know that engine hasn't shown any of the problems the Trent 1000 has and it has been in use for over 5 years by now if there was a problem we would know about it.

 

[Spekulatius]

My big concern is that in the case RR‘s future looks financially shaky, the government is going to facilitate a capital raise and doing what’s best for the UK, shareholder value be damned.

 

What would cause such a shaky financial future? The only thing I can think of is massive problems with the Trent XWB engine and so far as I know that engine hasn't shown any of the problems the Trent 1000 has and it has been in use for over 5 years by now if there was a problem we would know about it.

 

https://industryeurope.com/rolls-royce-downgraded-to-triple-b-minus-one-notch-above-junk/

 

RR is barely investment grade with a BBB- rating. Because of thr long term nature of its service contracts, it is likely that customer would get nervous if RR credit fell into junk and that might well trigger a capital raise. They need to get their house in order with respect to FCF - the H1 2019 results were Ok operationally, but there was a huge cash outflow which supposedly will be reversed in H2. If that is not the case, I think we have an issue with the credit rating and I may well exit immediately since it could become very ugly for her equity. Some of this might be priced in, but I don’t think all off it. Anyway, one want to be close to the door if someone yells fire.

[Xerxes]

Couple years back, ARM Holding (another crown jewel) was picked up by SoftBank right after the Referendum.

The British Gov authorized it on strict assurances that SoftBank would be adding more jobs. And i believe in the past few years, SoftBank has kept its words and re-invested ARM Holding's earning back into England and created more jobs.   

 

I think if something comes on that front in regards to RR, it will be with the British Government explicit OK.

Few years ago, British Gov was desperate to sell BAE to Airbus before Germany scuttled the deal, i am sure with BREXIT, the British Gov would see some merit in terms of having RR scale and under a stewardship of say larger company so that it can re-invest for the future.

 

Question is who will be to Rolls Royce, what Onex was to West-Jet?

of course it is all speculation on my side. 

[ValuePadawan]

 

https://industryeurope.com/rolls-royce-downgraded-to-triple-b-minus-one-notch-above-junk/

 

RR is barely investment grade with a BBB- rating. Because of the long term nature of its service contracts, it is likely that customer would get nervous if RR credit fell into junk and that might well trigger a capital raise. They need to get their house in order with respect to FCF - the H1 2019 results were Ok operationally, but there was a huge cash outflow which supposedly will be reversed in H2. If that is not the case, I think we have an issue with the credit rating and I may well exit immediately since it could become very ugly for her equity. Some of this might be priced in, but I don’t think all office. Anyway, one want to be close to the door if someone yells fire.

 

Interesting, well its another thing to keep an eye on in regards to the cash in the business I see that as unlikely but worth keeping an eye on.

[SharperDingaan]

I don’t think Brexit is a huge risk, as it is in both the EU (Airbus) and the UK‘s interest to keep the supply chain intact.

 

As for getting acquired, one has to consider that RR is a strategic asset for Britain and the government has a veto in important matters via a golden share. So, I don’t think that an acquisition by PE is in the cards.

 

My big concern is that in the case RR‘s future looks financially shaky, the government is going to facilitate a capital raise and doing what’s best for the UK, shareholder value be damned.

 

Re Brexit; think sterling devaluation post Brexit, not supply chain disruption.

 

SD

[ValuePadawan]

 

Re Brexit; think sterling devaluation post Brexit, not supply chain disruption.

 

SD

 

With a lot of their costs in pounds and revenue in US dollars I don't think that would be terrible.

[NotSoWise]

They have big hedging program. So not obvious how it will end... in the end.

[SharperDingaan]

 

Re Brexit; think sterling devaluation post Brexit, not supply chain disruption.

 

SD

 

With a lot of their costs in pounds and revenue in US dollars I don't think that would be terrible.

 

Think you're missing the point. Sell the shares today, put the proceeds into a USD T-Bill, let sterling devalue post Brexit. Sell the USD, get more sterling for it, & buy the shares back (hopefully at a lower price). Keep the FX difference and swing trade gain as profit. Nothing to do with what the company does.  ;)

 

SD

[Spekulatius]

RR announced results today and they look pretty good. Lots of noise, but it seems like things are better with the Trent engine and most importantly, FCF was decent.

https://otp.tools.investis.com/clients/uk/rolls-royce/rns/regulatory-story.aspx?newsid=1375472&cid=171

 

Obviously a lot of noise around the aircraft industry right now, but this does look very very cheap, if they generate 1 GBP in FCF/share. Stock is up this AM, deservedly so.

[kab60]

Agree, looks interesting. Also a bit on coronavirus/supply chains:

 

East said the coronavirus may hurt air-traffic growth in the near term but that long-term trends most affecting Rolls-Royce remain intact. Some suppliers in China did briefly close, but Rolls was able to rely on existing inventory, and those are now back up and running, he said.

[KCLarkin]

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.