What the future holds for Rolls-Royce

Rolls-Royce, the darling of British engineering, is down on its luck. Top line growth has slowed to a crawl, costs are not falling as fast as expected and now Russian trade sanctions have caused customers to delay or even cancel orders. The promised return to profit growth in 2015 will now be delayed for at least another year.

Clearly, Rolls didn't fancy issuing the warning a day before next week's marine capital markets day in Norway, so brought the scheduled update forward. It flagged up worsening market conditions, which were forcing customers to put off major investment decisions. Power Systems and Marine divisions have suffered most. The new Trent 7000 engines will also hurt sales of Trent 700s at the aerospace business.

"In the light of these uncertainties, our current best estimate for 2015 is that group underlying revenue will be in the range of +/-3% and profit in the range of 0% to -3% compared with our expected outcome for 2014 at constant exchange rates," warned Rolls.

Already trading close to a 21-month low, Rolls shares plunged as much as 13% Friday to 816p, their lowest since late 2012. It was Rolls' second warning this year. In February, chief executive John Rishton warned of flat revenue and profit this year, but was adamant business would pick up. "This is a pause, not a change in direction, and growth will resume in 2015," he said. He was wrong.

Cost-savings have offset the impact of Russian sanctions on orders, which means that 2014 profit, excluding a £60 million currency hit and one-off £30 million charge at Marine, will still be flat. But, according to analysts at Westhouse Securities, the 2015 forecast implies an operating profit of £1.69-£1.74 billion, over 5% lower than consensus estimates.

"That Rolls-Royce will weather this storm should not be in any doubt but as previously mentioned, I do believe that there are some lessons for Rolls-Royce to learn on messaging," said industry commentator Howard Wheeldon. "To have told investors only three months ago to expect a significant improvement in profit for the second half driven by higher revenue and cost reduction looks rather surprising in light of today."

At 832p, Rolls-Royce shares trade on just 13 times earnings per share (EPS) estimates for 2015. A big drop in defence business is factored in, and management is at least tackling costs, especially at the civil aerospace division. Yet, while bosses talk up civil aero prospects, they admit "it is difficult to make medium term forecasts with precision."

That's why investors will be nervous, especially given another year of no growth ahead. Rolls shares are currently sitting at major technical support. There's no guarantee this will hold, but as Wheeldon says, the company "will weather this storm". It may, however, take some time. One for the long-term.

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