Shares in Rolls-Royce had lost 39 per cent of their value from the start of 2014 when ValueAct Capital Management, the San Francisco-based activist investor, emerged on Friday with a 5.4 per cent stake. This is a startling fall for Britain’s most eminent engineer, although three profit warnings in the period will not have helped.
The last appeared just as Warren East was easing himself into the job of chief executive. ValueAct’s timing looks good. Rolls-Royce has been laid low by what look like largely short-term problems. Mr East has promised a review of its operations, but has talked down prospects of a sale of the non-aerospace business, even if analysts think that the marine side alone could be worth £6 billion.
The announcement about ValueAct came a day after Rolls-Royce had put out halfway figures that demonstrated some of those short-term issues. The marine side is being held back by the oil and gas downturn and is barely profitable, so now would not be a good time to sell.
In aerospace, Rolls-Royce is seeing less demand for its older Trent 700 engine as customers such as Airbus switch to the newer Trent 7000. It is having to spend on ramping up the XWB engine that goes into the A350. Such programmes are always less profitable at the early stages.
The company is moving from supplying engines on a “linked” basis to an “unlinked” one, changing the way profits on such contracts are accounted for and meaning that these are taken over the full length of the contract, with after-market supplies coming in later. It also is pushing towards a target of getting a half-share in that after-market in widebody passenger jets, which provides more reliable earnings.
ValueAct is, as activist investors go, relatively benign. It is not likely to move for a break-up of Rolls-Royce, while Mr East is sufficiently new to the job to be safe for now. Its policy appears to be one of holding the shares for the long term, while waiting for the benefits of those after market sales to arrive.
The company has been seen as a takeover target, but that looks implausible. The shares, up 47p at 841p, sell on 14 times’ earnings. Investors should take the same long-term view as ValueAct.
£76.5bn size of order book
MY ADVICE Buy
WHY The arrival of a long-term value investor should focus the market on upside for the shares, given the prospects for aerospace
A FTSE 100 company with little visibility but providing testing services to virtually every industry, Intertek has a reputation for boring reliability. The shares, though, have been pretty dismal performers over the past couple of years.
The main problem has been low commodity prices and, more recently, the low price of oil. This represents about 13 per cent of the business and, with capital spending by oil companies at a low, there is not a lot of new equipment to test. Intertek also has been exiting less profitable business, much of it in the oil and gas sector, as part of a general restructuring aimed at improving margins. First-half figures were rather better than the market had expected, with margins up by 60 base points to 15.2 per cent, with half of the improvement organic rather than down to more favourable exchange rates.
The market was encouraged by the fact that halfway figures came in ahead of expectations, if not by the fact that the oil and gas business will continue to be a drag. That and the disposal of some of that less attractive business sent revenues and profits into reverse in industry and assurance, the relevant division. By contrast the consumer goods, commercial and electrical and chemicals and pharma sides, which tend to command the higher margins, were well ahead, along with commodities, which is largely a proxy for world trade.
The shares romped ahead by 274p to £27.21. On more than 20 times’ earnings, they look well up with events.
Revenue £1.06bn
Dividend 17p
MY ADVICE Avoid for now
WHY Company is performing well, but this is in the price
Ultra has spent almost £300 million on acquisitions over the past couple of years, including its biggest yet in June, the $265 million purchase of an American electronic warfare specialist from the Nasdaq-quoted Kratos. In this way, it has progressed to a market capitalisation of more than £1.2 billion, all the purchases having been funded from debt and cashflow.
There have been headwinds, though. A contract to supply IT for Oman airport ended messily. Ultra has taken a £37 million provision for this and the matter is in arbitration, but it knocked a significant sum off revenues. In addition, American defence and to some extent Britain have been affected by pre-election spending slowdowns, orders by the US defence department falling by 7.5 per cent in the first half of this year. Include the Oman loss and revenues fell by 12 per cent in the first half, with underlying pre-tax profits off by 6.1 per cent to £47.4 million. The shares, up 30p at £17.75, have fallen since the summer and now sell on 14 times’ earnings.
Ultra will benefit fully from the inevitable upturn in defence spending, so the shares look like good long-term value.
Revenue £332m
Dividend 13.8p
MY ADVICE Buy long term
WHY Return of defence spending will boost earnings
And finally . . .
Chalk one up to activist investment, then. ENOC, the Emirates national oil company, has had to lift its bid for Dragon Oil to £8 a share after a campaign by Baillie Gifford and Elliott Advisers, who insisted that the previous offer was too cheap. I suspect that with the benefit of hindsight the bidder will still have been seen to have got a good price. The team at Westhouse Securities has been weighing up other bid prospects in the sector, highlighting Genel, Ophir Energy, Premier Oil, Rockhopper and Tullow Oil.
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