Few businesses have suffered more during the pandemic than Rolls-Royce. The company’s shares have been understandably wobbly since results for 2020 came out in March and they face a testing six weeks until the aerospace company publishes its numbers for the half-year to June 30.
Rolls declared a £4 billion loss for 2020 compared with a £306 million profit in 2019, after underlying revenue fell from £15.5 billion to £11.7 billion. The elephant trap was its reasonable-sounding policy of charging airlines for the hours its engines fly. Last year they hardly left the ground, forcing Rolls into a £7 billion emergency recapitalisation from loans and fresh equity.
It would be wrong to blame all the company’s ills on Covid. The shares had been sliding for nearly two years before the virus struck, from a peak of 375p in July 2018 when Rolls unloaded an oilrig equipment division. They sank to 38p last October, in what may have been the pit of the pandemic.
Beyond that, the long-run decline dates back to the 9/11 attacks in 2001, which put many people off flying until stronger security was installed. Brexit did Rolls no favours, either, and the industry was already suffering from chronic overcapacity. Quite a list confronting Warren East, an engineer appointed chief executive in 2015.
So investors will be waiting anxiously for words of cheer. At the annual meeting last month, East said that in the first four months of 2021 large-engine flying hours were 40 per cent below 2019 levels, but that the business was in a strong position for a rebound in international travel. East hoped that figure would rise to 55 per cent for the year and 80 per cent in 2022 (still lower than his initial estimates). Meanwhile, government work in military aircraft engines and power systems was said to be “resilient”.
A sign of faith in the future is the opening in Derby of Testbed 80, a huge indoor aerospace testing facility. The company is also supplying the engine for Dassault’s new Falcon 10X aircraft.
Charles Rolls first shook hands with Henry Royce in 1904 and they quickly established a reputation for making the world’s best-engineered, best-upholstered cars. In 1940 they did their patriotic duty by switching to aircraft engines for the war effort. The government wanted the company to continue to supply the RAF and it was a natural extension to enter the commercial airliner market. However, that — because of the huge capital investment and the years-long lead times between specification and take-off — transformed the business model. The flaws in that model came to a head 50 years ago, when cost overruns on the RB-211 engine forced Rolls into liquidation. The government nationalised the company, while the Rolls-Royce and Bentley car marques were bought by BMW and Volkswagen, respectively. The civil aerospace market now dominates the company’s revenue sources, followed by defence work and power systems such as engines for ships and factories.
The world will continue to demand superbly made, reliable aircraft engines, just not so many for the foreseeable future. East has been hacking away at costs almost since he arrived and he responded to Covid with plans to save another £1.3 billion a year. He hopes to turn Rolls cashflow-positive in the second half of this year. Eventually, his streamlining should cut deep enough to match the company’s lower horizons. It may not be quite there yet, but the share price suggests buyers are ready to step in whenever it flirts with 100p.
On the hope that in August East reports reduced losses and calmer operations, this could be the time to make a modest bet on recovery. But, under the terms of loan agreements, dividends are off-limits until 2023.
ADVICE Cautious buy
WHY The bulk of the bad news may have been baked into the shares at last, but this is unlikely to be a smooth ride
DS Smith
Shares in DS Smith have been soggier than a rain-soaked cardboard box since they hit a 2021 peak of 445p on June 7 — and the annual results announced on Tuesday did nothing to halt the slide, taking them down to last night’s close of 419¾p. After a strong run from 258p in August last year, investors may have been taking profits, but that looks premature.
The firm is Britain’s largest 100 per cent producer of cardboard and paper from recycled waste, which plonks it slap in the middle of the ecommerce boom. Covid restrictions may have helped to close Debenhams, Topshop and other high street favourites, but they were wonderful news for the packaging and delivery industries.
The online market leader is, of course, Amazon, which attracts thousands of investors wanting to ride the monster of the ecommerce boom. However, just as fortunes were made less riskily from selling spades than digging for gold, Smith is one of those companies that does very nicely from supplying Amazon, as well as the big food manufacturers such as Unilever and Nestlé.
The contrast between Smith and Amazon shares is instructive. Aside from the dollar exchange-rate risk for UK investors buying Amazon, Smith shares are far better value. At $3,505 a share (yes, you read that correctly), Amazon sells on 66.7 times earnings and Jeff Bezos, the founder, scorns dividends. Smith’s shares are on 32 times earnings and carry a 2.9 per cent dividend yield.
Grand View Research predicted this week that global demand for corrugated board packaging would rise by 6.5 per cent a year for the next seven years. Miles Roberts, Smith’s chief executive, says modestly that “we expect to make good progress this year” as the Covid effect unwinds.
Analysts at Peel Hunt have raised their target share price to 460p and their counterparts at Credit Suisse look to 470p. Early last month Tempus recommended them at 420p and this week’s bulletin only underlines that.
ADVICE Buy
WHY Eco-friendly materials supply a booming industry
