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28 August 2020

Rolls-Royce


Ben Staniforth, Research Analyst, Redmayne Bentley

Coronavirus has caused the majority of sectors to fall into decline, with only a few large tech firms thriving on the situation. The Transport and Aviation sector is amongst the sectors most affected by the pandemic, and Rolls-Royce, as an aerospace engineering company, has been suffering the consequences.

The company announced today that pre-tax losses for the first half of the year amounted to £5.4bn. Warren East, the CEO of the engineering giant, does not expect demand to recover for its engines until 2025. The pandemic is likely to cause long-term effects on the travel industry as a whole. In the short term, the industry is suffering from major holiday destinations imposing strict travel bans both in and out of the country, and, with these destinations locked down, those willing to fly have significantly reduced options. In addition, with people being unwilling to fly due to the risks to their health, the client base of airlines has shrunk. This has caused severe revenue effects for the firm. Rolls-Royce does not generate a profit on the sale of its engines but rather on the flight hours of the engines as utilised by airlines, therefore, due to reduced demand, flight hour revenues generated under long-term service agreements will be significantly lower.

Beyond external demand factors driving down revenues, the company there are internal influences affecting its stability. Rolls-Royce is having to undergo the largest restructuring in its history. The company intends to reduce its global number of employees by a fifth, which explains the closure of factories in Nottingham and Lancashire, the first steps in eliminating 3,000 jobs within the UK alone. The company already possessed a weak balance sheet heading into the pandemic and is now suffering the consequences, with intentions currently to dispose £2bn worth of assets in order to raise capital. Analysts expect that this will not be enough to cover longer term losses and that Rolls-Royce may partake in a rights issue, again raising another £2bn as current shareholders purchase shares at a discount value. Even with cost cutting strategies in place, the company generated an operating loss of £1.7bn, but a large loss came from its US Dollar hedging positions. Due to reduced air travel, a reduction in revenue streams from the US can be expected and, therefore, the company closed its hedging positions, previously used to reduce exchange rate exposure from the US, which cost the company £2.5bn. The restructuring costs round the losses up to £5.4bn.

Not only is Rolls-Royce suffering financially but also key personnel are leaving in light of the company’s distress. Stephan Daintith, the Chief Financial Officer, has resigned and is moving to Ocado in due course, but will remain until November to support the transition. The question arises, is the worst over yet? Likely no, with several analysts suggesting that government support may be required due to the extent of the firms UK operations, in which it employs around 25,000 people.

Please note that investments and income arising from them can fall as well as rise in value. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
 
 

 
 
Rolls-Royce
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