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Rolls rocked after warning
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August 24, 2000: 8:00 a.m. ET
Stock down on gloomy 2001 outlook, even as first-half profit is announced
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LONDON (CNNfn) - Rolls-Royce PLC saw its shares tumble nearly 23 percent Thursday after the British aero engine maker warned it expected no growth in its core profit next year, even after operating profit for the first half of 2000 jumped by a quarter, matching analysts' estimates.
Rolls-Royce said underlying pretax profit in the first half of 2000 rose to £195 million ($288.8 million), or 9.79 pence a share, from £155 million, or 7.91 pence per share, a year ago in the period. Analysts had forecast a pretax profit figure of between £170 million and £205 million.
Shares of Rolls-Royce (RR-), which was separated from the car maker of the same name in the early 1970s, sank 49.5 pence, or 22.7 percent, to  169 pence on the London Stock Exchange, after earlier falling as low as 166 earlier.
"I don't think there could be anyone who wasn't surprised by this 2001 earnings warning," said Howard Wheeldon, an analyst at Prudential-Bache Securities in London who lowered his rating on the company from "buy" to "hold" Thursday after the announcement.
Commerzbank downgraded Rolls-Royce stock to a "sell" from a "hold." Merrill Lynch lowered its rating to "neutral" from "buy," while Credit Suisse reiterated its rating at a "buy."
First-half sales rose 33 percent to £2.8 billion, with about half of that coming from the civil aircraft sector, and sales of engines to the defense industry accounting for about one-quarter of total sales. The company also makes engines for use in the shipping, power-generation and
The company said rising sales of new engines - a business with low profitability - was likely to crimp profit in 2001. More new-engine sales means a deteriorating business mix, as higher-margin activities, like the servicing of older engines and component sales, take up a smaller percentage of the overall business.
"They've got close to 58,000 engines installed, but a lot of them are relatively new, which means that they don't need a lot of maintenance," said Wheeldon. He said the retirement this year of about two-thirds of the Tristar planes in operation, which run exclusively on Rolls-Royce engines, and the retirement of select Boeing 747s had reduced service needs.
Deliveries of engines for civil airplanes have more than tripled over the past five years, from about 400 per year in 1995 to about 1,200 in 2000, Rolls-Royce said.
"Margins in the aftermarket are much higher for us than is the original equipment manufacturing market," said Sir Ralph Robins in an interview with CNNfn.com. He said that its spare parts business is growing at about 5 percent a year, while new equipment unit is growing at about 25 percent.
'Lovely problem'
"It's a lovely problem to have ... we are generating a huge imbedded value," he added, admitting the company is a victim of its own success. The company estimates the aftermarket business will generate about £14 billion over the next 25 years.
Wheeldon said profit margins for the sale of civil aircraft engines are roughly zero-to-one percent, and profit margins in the service and spare-parts business are about 30 percent. Profit margins in the military aircraft business are about 12 percent, he added.
Other factors that will hold back next year's profit are expected restructuring charges, and a delay in sales of its new Trent jet engine as Rolls-Royce works to perfect the engine's emissions-control technology.
Net profit fell 94 percent to £8 million, or 0.51 pence per diluted share, in the first half of 2000, down from £123 million, or 8.09 pence a share, last year. That first-half 2000 drop is partly due to a £120 million provision for delays related to the Trent engine.
However, Rolls-Royce expects double-digit earnings growth through the end of 2000 and said it would continue to reduce its debt. The company  also said it was "confident" that earnings growth will re-ignite in 2002.
A new efficiency program will require investment of about £50 million the year over the next 3 years, said the company. The company has announced plans to cut 2,000 next year to boost efficiency.
"They are going to have to get costs down, they're going to have to cut more jobs," said Wheeldon. "They have let down again after having just won friends - why should we trust Rolls again?"
As part of its analysts' presentation on Thursday, Rolls-Royce said it currently holds about 30 percent of the market for new engines. General Electric (GE: Research, Estimates) is the market leader, with an estimated 40 percent, while United Technologies' (UTX: Research, Estimates) Pratt & Whitney and France's state-owned SNECMA each have less than 20 percent, according to the Rolls-Royce numbers. 
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Rolls-Royce
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