Aircraft engine maker Rolls-Royce (RR.) slumps 14.4% to £10.36 as it indicates profits and revenues will show no growth this year thanks to a slowdown in defence spending.


Web chart - Rolls-Royce - Feb 14

This makes 2014 the first year of flat revenue in more than a decade (since 2003) with the contribution from defence markets down some 15% to 20%. Peer BAE Systems (BA.) falls 3.4% to 424.7p in sympathy. It has not been a good week for the £20.1 billion cap as today's disappointing update follows the arrest yesterday of two men in London as part of an investigation by the Serious Fraud Office (SFO) into the company's activities in Asia.


Chief executive officer John Rishton describes this year as a 'pause not a change in direction' with marine also expected to see a modest reduction in revenue. Elsewhere civil aerospace is anticipated to see modest growth in revenue and good growth in profits.


Looking at the 2013 numbers in detail, Rolls-Royce reports £1.76 billion in underlying pre-tax profit for 2013, a rise of 23% from the year before. However headline pre-tax profit falls 36%. The difference is mainly due to a smaller hedging gain and a fall in profits from disposals.


Revenue is up 27% at £15.5 billion and diluted earnings per share were 72.44p, down from 123.73p. The aftermarket component of group revenue reduces from 52% in 2012 to 47% in 2013. Arguably this reduces the resilience of the group's earnings slightly. The order book – an important gage of future earnings – was up 19% to £71.6 billion and the dividend is also hiked 13% to 22p. Free cashflow totals £781 million.


Jefferies – previously a buyer of Rolls-Royce with a price target of £14.00 - comments: 'In short, defence takes a sharp step back to where it was in 2010... We saw it coming to a degree, but were wrong-footed by defence doing better than we expected between 2011 and 2013.'


Sash Tusa, analyst at research house Edison, says 'Rolls’ management is likely to focus on the operational challenges associated with the falling defence backlog and transition to a high level of Trent XWB deliveries.


'Within the context of falling defence orders in the industry, the continued news-flow concerning the SFO investigations, and yesterday's arrests, are likely to be an unwelcome distraction, but not core to the investment case. Most investors will be reassured by the company’s forecast of cashflow broadly similar to 2013, given that cash is one of the key components’ of CEO John Rishton’s 4Cs priorities.'

Issue Date: 13 Feb 2014