Photographer: Chris Ratcliffe/Bloomberg

Rolls-Royce CEO Faces Biggest Challenge After Slowing Slide

  • East cheers City by maintaining outlook, reporting progress
  • But dividend halved and management cut with more pain to come

Rolls-Royce Holdings Plc Chief Executive Officer Warren East impressed investors enough to send the engine-maker’s stock up the most in 12 years after ending a run of profit warnings and reporting that the beleaguered business is showing signs of stability.

In reality his toughest challenges may still lie ahead as Rolls-Royce braces for earnings to plunge this year and grapples with declining markets for offshore oil vessels, regional jets and business aircraft where it can do little more than trim engine production costs and wait for sales to revive.

East cheered shareholders Friday by reporting 2015 earnings within the company’s guidance and saying the outlook for this year remains on track. Relief at avoiding a sixth profit warning in two years was sufficient to send the stock up 14 percent even after he cut the final dividend for last year by 50 percent.

“If East can successfully restructure the business into a shape fit for purpose, there could be upside,” said Steve Clayton, head of equities research at Hargreaves Lansdown. “But the concern must be that it will take so long that by the time it can be seen to have worked, the market for civil aerospace will have turned down.”

Hundreds of Orders

Rolls-Royce faces the biggest engineering challenges in its history as the London-based company seeks to double production of its Trent airliner engine range to fulfill hundreds of orders for new planes including the Boeing Co. 787 Dreamliner and Airbus Group SE’s A350. While that will increase costs, it won’t immediately lift earnings, which are tied more to service revenue that begins to flow as turbines get older.

At the same time the market for some older engines on which Rolls-Royce has relied for maintenance work has begun to dry up. East has said that the company has not been nimble enough to respond to the changing situation -- though measures he has put in place mean that’s beginning to change.

“I do feel that we’re on firmer ground,” the CEO, who assumed the top post at Rolls-Royce in July, said on a conference call. “Fixing the issues is a long-term program. You get through most of it quite quickly, and yes, we’re feeling more confidence in that, but no, the work is not complete by any means.”

Rolls-Royce stuck to its November forecast for a 650 million-pound ($943 million) hit to 2016 earnings as corporate jet sales to Russia, Brazil and China and marine engine demand are hit by the collapse in oil revenues. The stable forecast “should help stop the rot in sentiment,” Sandy Morris, an analyst with Jefferies International Ltd. said in a note.

Sliced Dividend

The first cut to Rolls-Royce’s annual dividend since 1992 helps Rolls-Royce preserve cash and protect its credit rating. Restructuring charges this year may reach 100 million pounds, East said, adding that “further reductions” will be necessary after already cutting about 50 of the company’s top 200 managers. He’s also taken a clearer view on which parts of the marine business may be up for disposal.

East also said Rolls-Royce is focused on “execution and transformation” rather than seeking out partners, adding that the lowered dividend amounts to an effective “rebasing” and the payout probably won’t rebound immediately to its former level. The dividend cut and other steps to bolster Rolls-Royce’s cash position means a rights issue isn’t in the works at the moment, Chief Financial Officer David Smith said.

The final payout for 2015 will be reduced to 7.1 pence per share from 14.1 pence and the interim payment for this year will also be cut by 50 percent. The company will review future dividend payments at mid-year.

Underlying profit for last year fell 12 percent at constant exchange rates to 1.43 billion pounds, while sales slipped 1 percent to 13.4 billion pounds. Rolls-Royce’s pretax profit for 2015 was within a range of 1.325 billion pounds to 1.475 billion pounds forecast in November.

‘Pivotal Year’

The company’s shares climbed as much as 19 percent to 629 pence before closing at 606 pence in London. Prior to Friday’s release, Rolls’s share price had fallen 7.8 percent this year and 39 percent since East took over in July.

“We need to add pace and simplicity into this business,” East said during a presentation with analysts. “2016 is going to be a pivotal year and getting off to a good start is essential.”