RR - Rolls-Royce

[KCLarkin]

I haven't listened to the call, but it sounds like there is a glut of older planes. Everyone ordered new planes when oil prices were high. Now they are taking delivery of the new jets but don't have traffic demand to keep older jets busy.

 

If true, this is very worrisome. Maybe aerospace really is in a bubble.

[Picasso]

That ties into the airline comments made earlier in the year about a bubble in used planes. I thought posters here said it wasn't a big deal for Rolls?

[handycap5]

That ties into the airline comments made earlier in the year about a bubble in used planes. I thought posters here said it wasn't a big deal for Rolls?

 

thanks for the comments - let's keep going on it. i think the answer is more nuanced than this. first, load factors are at all-time highs. second, the OEM backlogs appear very firm.

 

has the aircraft fleet cost-supply curve shifted up (in spite of cheaper kerosene) so there are more planes being parked? are new planes that much more effiecient than the last many years? if the engine guys are the primary reason for the increased efficiency, why is their business struggling so much? did they misprice the razor-razorblade model (CFO of RR on the call said engines still last 25 years, but I question this)? how is it possible there is such a disparity between RR and GE's widebody engine business? will the engine guys try to renegotiate their deals with the OEMs (they do have exclusives!)?

[Spekulatius]

I sold a few shares to harvest tax losses. I am pretty convinced that RR is a good business, but we may indeed be going into a dos cycle, potentially caused by lower fuel prices, hat make operating older aircraft economical.

 

I don't really know, but my rule is to sell, if fundamental move against my position much more so than expected, and that is certainly he case with RYCEY.

[KCLarkin]

I sold out. The business has is clearly in worse shape than I thought.

 

[fareastwarriors]

Do you think this is a good buy-out target?

[KCLarkin]

Yes, but the UK owns a golden share and the natural bidders would spark antitrust concerns. A takeover seems obvious but not easy.

[jay21]

Evolving thoughts, links, and snippets:

 

Latest CC:

 

"We are seeing significant changes in some of our end markets. It is primarily lower demand within corporate and regional markets, and reduced utilisation of older wide-body jets. We’re also seeing continued and more severe deterioration in the offshore Marine part of our business."

 

"We’ve set out in the statement and outlined on the slide the key factors that we see providing the

challenges for the coming year. £650 million headline figure comprises £300 million which we identified

in July; in particular, relating to the impact of the slowdown in the Trent 700 order book. I’d note that we

believe our initial estimation of this impact remains absolutely valid today. The next component is

£100 million in corporate and regional jets. That’s because we’re seeing further weakness in the

demand for business jet engines, in particular for new orders, as well as further weakening in demand

for aftermarket services for the smaller 50–70-seat regional aircraft.

 

Then, in our large engine business, we have between £100–150 million of headwind. We’re seeing

good growth in installed thrust, but that’s being offset by some short-term weakness on older,

wide-bodied programmes. And this is where our engines are being temporarily parked up, as some

people in the industry manage a transition to newer and more efficient aircraft. Finally, there’s between

£75–100 million of further headwinds in the Marine part of our business, where the market in offshore in

particular continues to weaken both for original equipment sales and for services.

 

So the profit effects are really quite dramatic, but the impact on cash flow is a lot less. And the reason

for that is the non-cash nature of the TotalCare accounting adjustments in both 2015 and 2016. And

there’s a difference where those adjustments are much more significant in 2015 than they are in 2016.

And there’s an expected benefit in 2016 of improved working capital as well."

 

J21: Issues primarily relate to legacy engine and non-core assets. I think the thesis rests primarily with new generation engines. Also, management needs to be very clear on the non-cash impact. How could these slowdowns not impact cash flow? It appears WC might offset negative drags?

 

"Now, we’ve given a 2017 view just in terms of saying that, you know, we expect the impact of some

these new changes that we’re announcing to impact in 2017. It’s too early to talk about the impacts of

the parked-up aeroplanes on 2017. Some of this – you know, it’s a very select number of airlines that

are involved at the moment. Some of them are – they’re basically balancing capacity and demand, and

there’s new, more efficient aeroplanes out there, and those planes are being bought to increase

capacity. Meanwhile demand wobbled slightly, and so the obvious thing to do is park up the less

efficient engines, and use the planes with more efficient engines. I think it won’t be – it’s really too early

to say, you know, is it a temporary effect that will be over and done with by 2017? In the long term the

demand is certainly there, so we do expect to see the overall number of aeroplanes being used

continue to increase. And so I suspect that it is temporary, and that it is going to be a progressive

recovery, but it’s really a bit too early to say, ‘This will all be complete by 2017.’"

 

"In terms of long-term margins: no, I’m still very confident about that. That’s driven – as I hinted in the

last answer about the long-term growth in the installed base for the new Trent engines, that will

generate significant improvements in cash flow and operating margins and return on capital, over time.

I think we’re talking about the transition effects on the legacy programmes primarily, here."

 

"In terms of the downside risk on the legacy aftermarket portfolios: we’ve modelled that and looked at

that as closely as we can, but there clearly is a big transition going on both in the narrow-body and the

wide-body side of the business. And I think that we are not alone in experiencing this; I’ve seen

comments from several other companies, both on the airline side and the supplier side within the

industry over the last few weeks, and I think what we’re seeing is part of a pattern. And that may well

change further, and we’ve got to be prepared, as Warren said, for that, and therefore more resilient to

those sort of fluctuations; that’s really why we’re taking the action that we’re taking."

 

J21: I see a fair amount of color on narrow body. What wide body weakness is out there?

 

"Streamlining senior management, simply so as if you’re going to be doing different things then, you

know, maybe senior managers will end up doing different things and maybe we won’t need quite so

many people."

 

J21: Execs should be nervous

[jay21]

Rockwell Collins forecasts lower biz jet revenues: http://aviationweek.com/business-aviation/rockwell-collins-expect-weak-market-business-aviation-2016

 

Color on Rolls Royce and Bombardier: http://business.financialpost.com/news/rolls-royce-profit-warning-signals-broader-weakening-in-aircraft-demand

 

JPM Note:

 

"Aftermarket showing signs of weakness but not across the board. Given the

size of its aftermarket business (~$12 bn for Pratt and UTAS) the guide down at

UTX dominated this reporting season. Some of this was company-specific but

not all with COL (N) guiding down as well, along with MTU in Europe. We

have seen ups and downs in the aftermarket since the destock/restock cycle that

accompanied the recession and it is not wholly surprising that demand is

choppier with so many new aircraft being delivered, potentially crowding out

spares and maintenance for older planes. Based on anecdotal evidence, our

concerns for the aftermarket revolve around increased supply of some types of

spares, perhaps from retired aircraft or players in the secondary market, and

airline and MRO efforts to thin out inventories. Not all of the aftermarket was

weak, with robust growth in spares for newer narrowbody engines, including

33% y/y commercial spares growth at GE and 38% at Safran propulsion, both

driven by CFM56, as well as Pratt, where V2500 spares were up 30%+."

 

"Commercial aircraft demand remains solid. Amid weakness in the aftermarket

and concerns about business jets, commercial OE was steady, with Boeing and

Airbus each confident in planned rate increases. In addition, annualized 1H15

cancellations were only 1% of the Boeing and Airbus backlog, suggesting that

airlines are not responding to lower oil prices by canceling new aircraft to fly older

ones longer. In fact, far from signs of weakness, Airbus indicated that demand is

sufficient to boost A320 production above the planned rate of 50/month (perhaps to

~60) with supply chain capacity being the pacing item. We have expressed

ambivalence about higher production rates, given that they heighten overproduction

risk and could inspire more skepticism of the cycle but the fact that they

are on the table suggests there is little in the near term to derail new aircraft

demand. OE strength is consistent with our OW ratings on BA and SPR. OE is the

key end market driver for each, with stock specific catalysts as well: in Boeing’s

case, this is improving 787 cash flow; for SPR, there is continued operational

improvement and capital deployment."

[Picasso]

I can see how Rolls shows half the margins of GE. It looks like their production line is stuck back in the 1990's.

 

You also have a town built around Rolls. Sort of hard to cut jobs or make big organizational changes.

 

Kind of funny to look back and see people on the board make fun of my comments back then.  Then we get these comments from the CEO:

 

The company is also burdened by costs from inefficient “legacy” production facilities, which will at least disappear when Rolls-Royce is able to eliminate older programs and machinery over the next few years, he said.

 

or this which sounds like code for lots of people doing things very inefficiently:

 

“We’ve just built up loads of processes here over the years,” East, who took over in July, said by telephone Friday. “They’ve all been added to, one on top of another on top of another, and it’s time to clean it up a bit. Our speed of reaction to changes in the market is not good enough.”

 

Anyway not to make fun of anyone but you really could tell a lot from that YouTube video posted earlier in the thread.

[portfolio14]

J21: Issues primarily relate to legacy engine and non-core assets. I think the thesis rests primarily with new generation engines. Also, management needs to be very clear on the non-cash impact. How could these slowdowns not impact cash flow? It appears WC might offset negative drags?

 

"Now, we’ve given a 2017 view just in terms of saying that, you know, we expect the impact of some

these new changes that we’re announcing to impact in 2017. It’s too early to talk about the impacts of

the parked-up aeroplanes on 2017. Some of this – you know, it’s a very select number of airlines that

are involved at the moment. Some of them are – they’re basically balancing capacity and demand, and

there’s new, more efficient aeroplanes out there, and those planes are being bought to increase

capacity.

 

This talk about "legacy" vs "new" sounds like smoke and mirrors. RR's aftermarket revenue is proportional to total thrust x flying hours and the difference between old and new engines shouldn't be material. So, in a nutshell, aircraft utilisation has gone down because there is currently an oversupply. Saying it's "legacy" just makes it sound like it's a problem inherited from past. Naughty mgmt.

 

Meanwhile demand wobbled slightly, and so the obvious thing to do is park up the less

efficient engines, and use the planes with more efficient engines. I think it won’t be – it’s really too early

to say, you know, is it a temporary effect that will be over and done with by 2017? In the long term the

demand is certainly there, so we do expect to see the overall number of aeroplanes being used

continue to increase. And so I suspect that it is temporary, and that it is going to be a progressive

recovery, but it’s really a bit too early to say, ‘This will all be complete by 2017.’"

 

After the Paris incident, the temporary-ness may stretch to years...

 

[TheAiGuy]

--Jay

 

I think the crux of the thesis is that long-term, the wide body market will grow. You're right that on the conference call it wasn't clear how much the wide-body market was effected, though the mention of some aircraft being parked is troubling.  If the revenue/profit drop of is largely due to linked vs unlinked sales, then whatever, but I'm not sure what to make of the parked aircraft bit.

 

I suspect that cash-flow from changes in working capital will have to do with a draw down of inventory, but that's a guess based on previous initiatives. Its not surprising that cash flow is less effected then revenue/profit, as their accounting brings forward revenue recognition from future periods of time (though, it seems it understates economic value). The cash flow stuff is good news, though, b/c it means they aren't in danger of bankruptcy.

 

[KCLarkin]

The legacy versus new distinction is important. RR is expected to have a larger share of the wide body market on the new programs. I think you would prefer the airlines to park old planes than cancel new orders.

[TheAiGuy]

The legacy versus new distinction is important. RR is expected to have a larger share of the wide body market on the new programs. I think you would prefer the airlines to park old planes than cancel new orders.

 

That's a good point but it is is also important to note that the thesis (well, mine at least) is predicated not only on increasing share of the wide body market, but also its overall growth in size. Parked aircraft would be relevant to that.

[portfolio14]

The legacy versus new distinction is important. RR is expected to have a larger share of the wide body market on the new programs. I think you would prefer the airlines to park old planes than cancel new orders.

 

That's a good point but it is is also important to note that the thesis (well, mine at least) is predicated not only on increasing share of the wide body market, but also its overall growth in size. Parked aircraft would be relevant to that.

 

Both are good points.

[jay21]

To synthesize the legacy issue:

 

Right now Rolls engines are going through a refresh led by the two new Airbus launches. However, they have some engines that are not being produced anymore but they are making aftermarket profits.

 

What happened is Rolls is not participating in new biz jets. This segment has experienced the biggest headwind recently. So the old jets were parked, which led to decreased aftermarket revenue on legacy jets. However, the new jets were being flown because they are more fuel efficient, which is why GE was able to show a decent quarter because they a presence in the new jets.

 

They key is still getting the new wide body jets up and running. I don't think that part of thesis has changed. It's "demand choppiness" right now.

[portfolio14]

To synthesize the legacy issue:

 

Right now Rolls engines are going through a refresh led by the two new Airbus launches. However, they have some engines that are not being produced anymore but they are making aftermarket profits.

 

What happened is Rolls is not participating in new biz jets. This segment has experienced the biggest headwind recently. So the old jets were parked, which led to decreased aftermarket revenue on legacy jets. However, the new jets were being flown because they are more fuel efficient, which is why GE was able to show a decent quarter because they a presence in the new jets.

 

They key is still getting the new wide body jets up and running. I don't think that part of thesis has changed. It's "demand choppiness" right now.

 

jay21, not biz jets. From the script:

 

"Then, in our large engine business, we have between £100–150 million of headwind. We’re seeing

good growth in installed thrust, but that’s being offset by some short-term weakness on older,

wide-bodied programmes. And this is where our engines are being temporarily parked up, as some

people in the industry manage a transition to newer and more efficient aircraft."

[jay21]

I guess it's both because right before they mentioned biz jets.  I have seen more color on the biz side. Time to check UTX and GE.

 

"The next component is

£100 million in corporate and regional jets. That’s because we’re seeing further weakness in the

demand for business jet engines, in particular for new orders, as well as further weakening in demand

for aftermarket services for the smaller 50–70-seat regional aircraft."

[portfolio14]

I guess it's both because right before they mentioned biz jets.  I have seen more color on the biz side. Time to check UTX and GE.

 

"The next component is

£100 million in corporate and regional jets. That’s because we’re seeing further weakness in the

demand for business jet engines, in particular for new orders, as well as further weakening in demand

for aftermarket services for the smaller 50–70-seat regional aircraft."

 

Fair enough.

[Spekulatius]

I guess it's both because right before they mentioned biz jets.  I have seen more color on the biz side. Time to check UTX and GE.

 

"The next component is

£100 million in corporate and regional jets. That’s because we’re seeing further weakness in the

demand for business jet engines, in particular for new orders, as well as further weakening in demand

for aftermarket services for the smaller 50–70-seat regional aircraft."

 

I sold my UTX on the day RYCEY released their bad news. Something is clearly happening in the aircraft industry and it does not look good.

[handycap5]

 

I sold my UTX on the day RYCEY released their bad news. Something is clearly happening in the aircraft industry and it does not look good.

 

what is clearly happening in the aircraft industry, in your view?

 

1) load factors are at all time highs. I would be surprised if the Asians and all the rest of us stopped traveling: http://www.iata.org/publications/economics/Pages/Air-Passenger-Monthly-Analysis.aspx

2) OEMs have unusally long backlogs.

 

what confuses me is the parking of old 777's given lower oil prices and high load factors...

 

[jay21]

 

I sold my UTX on the day RYCEY released their bad news. Something is clearly happening in the aircraft industry and it does not look good.

 

what is clearly happening in the aircraft industry, in your view?

 

1) load factors are at all time highs. I would be surprised if the Asians and all the rest of us stopped traveling: http://www.iata.org/publications/economics/Pages/Air-Passenger-Monthly-Analysis.aspx

2) OEMs have unusally long backlogs.

 

what confuses me is the parking of old 777's given lower oil prices and high load factors...

 

It's more the choppiness of what's going on. After a cursory glance, UTX and RR posted disappointing legacy service results. But GE seemed to do fine on their legacy business.

[KCLarkin]

Yes, this is the confusing part. The demand for used wide bodies should be high given the current backlog at the OEMs and the low oil prices. One of the main buyers of wide bodies is the Gulf countries. Given the low oil prices, maybe that is the source of the weakness?

[Spekulatius]

Yes, this is the confusing part. The demand for used wide bodies should be high given the current backlog at the OEMs and the low oil prices. One of the main buyers of wide bodies is the Gulf countries. Given the low oil prices, maybe that is the source of the weakness?

 

I think the lower crude prices have a lot to do with the weakness. Newer airplanes with newer engines are more fuel efficient, but with kerosine prices down 60%, who cares. It's cheaper to fly the old birds that are mostly depreciated. While RR may have a huge backlog, the customer still can push out deliveries in many cases (at least that is what usually happens in these cases, where the customer ordered something , but does not really need it when it's build).

 

Some or RR's problems are certainly homemade, but since many other companies in aerospace have weak numbers, I think there is more to it.

[TheAiGuy]

Yes, this is the confusing part. The demand for used wide bodies should be high given the current backlog at the OEMs and the low oil prices. One of the main buyers of wide bodies is the Gulf countries. Given the low oil prices, maybe that is the source of the weakness?

 

I think the lower crude prices have a lot to do with the weakness. Newer airplanes with newer engines are more fuel efficient, but with kerosine prices down 60%, who cares. It's cheaper to flee the old birds that are mostly depreciated. While RR may have a huge backlog, the customer still can push out deliveries in many cases (at least that is what usually happens in these cases, where the customer ordered something , but does not really need it when it's build).

 

Some or RR's problems are certainly homemade, but since many other companies in aerospace have weak numbers, I think there is more to it.

 

I think this is backwards -- older planes generate higher service revenue through T&M. Any plane on TotalCare that is parked won't generate service revenue as that is proportional to the hours flown, and many of the older aircraft may still have TotalCare agreements.

 

Also, the A350 program has been delayed due to delays with rollout on Airbus's side, not demand. Finnair, for example, has had to push back starting planned routes due to delays in delivery.