Rolls-Royce Holdings Plc

Rolls-Royce Holdings Plc (LON: RR.) is a London, United Kingdom-headquartered multinational engineering Company. It focuses on power and propulsion systems.

Investment Highlights: Rolls-Royce Holdings Plc – Buy at GBX 210.60

• To reduce the impact of Covid-crisis, RR has launched Fundamental restructuring of Civil Aerospace, including consolidation of global facility footprint and reduction in headcount, to achieve annual pre-tax savings of £1.3 billion by 2022 end.
• On the liquidity front, Rolls-Royce Holdings Plc’s current ratio of 1.02 was slightly lower than the industry median of 1.07. Despite the lower liquidity, the Company has sufficient liquidity profile to tackle the uncertainty due to covid-19 outbreak.
• As per valuation metrics, EV/EBITDA, Price/Earnings and Price/Book Value multiples of the Rolls-Royce Holdings Plc are currently lower as compared to the corresponding multiples of the Aerospace & Defense It reflects, shares are undervalued as compared to the industry.

Key Risks

• COVID-19 is causing substantial disruptions to the respective supply chains and the end markets, while the customer demand is shrinking as activity levels have reduced.
• The Group is exposed to a number of market risks, some of which are of a macro-economic in nature such as, fluctuations in foreign currencies, oil prices, and interest rates.

Financial Highlights – H1 Financial Year 2020 (30 June 2020)

(Source: Interim Report, Company Website)

• In the first half of the financial year 2020, the reported revenue declined by 26%, and underlying revenue declined by 24%, reflecting lower revenue from Civil Aerospace, Power Systems and ITP Aero businesses.
• Due to the impact of covid-19 resulted in one-off charges in Civil Aerospace of £1.2 billion, the underlying operating loss stood at £1.7 billion; reported operating loss stood at £1.8 billion.
• On the Liquidity front, the Company has a cash balance of £4.2 billion as on 30 June 2020, along with RCF (revolving credit facility) of £1.9 billion. The Company also announced term loan backed by UKEF (UK Export Finance) for £2 billion in July and finalised in August.

One Year Share Price Chart

Daily Chart as of 1 September 2020, before the market close (Source: Refinitiv, Thomson Reuters)

Technical Performance

From the technical standpoint, 14-day RSI is currently close to an oversold zone, which means there is a good potential for a short term rebound in the stock price.

Valuation Methodology

Conclusion

The Company has shown a decline in financial performance for the first half of the financial year 2020. The Company expects the market to remain uncertain despite the economic recovery and easing of travel restrictions. RR believes business recovery will commence by the end of H2 FY2020, based on a gradual recovery in civil aviation.

The Company expects the majority of Power Systems end markets will recover by the end of 2021, and revenue will reach normal levels in 2022, while Defense performance stood resilient. The Company expects large engine deliveries to increase gradually beyond 2022. The underlying revenue in FY2020 is expected to be 25% to 30% below FY2019 data, with free cash outflow of around £4 billion, liquidity of £6 billion and net debt will increase to £3.5 billion approximately. The Company is targeting to return to positive free cash generation by H2 FY2021 and free cash outflow in FY2021 will be significantly lower versus FY2020.

Based on the above rationale and support from the valuation as done using the above method, we have given a “BUY” recommendation for Rolls-Royce Holdings Plc at the current price of GBX 210.60 (as on 1 September 2020, before the market close at 1:45 PM GMT+1), with lower double digit upside potential based on 0.87x EV/NTM Sales (approx.) on FY20E sales (approx.).

Meggitt Plc

Meggitt Plc (LON: MGGT) is an Aerospace and Defense company which provides components, sub-systems and advanced technological solutions for defence, aerospace and energy applications.

The Company will make an interim announcement on 8 September 2020.

Investment Highlights: Meggitt Plc – Buy at GBX 270.60

• The Company has a strong liquidity position to mitigate the impact of the covid-19 pandemic and is presently trading in line with management expectations with a reduction in Debt/Equity ratio from the financial year 2016.
• Despite the tough market condition, the Company expect defence business to deliver mid-single digits organic revenue growth in H1 FY2020 with robust demand and decent order flow.
• As per valuation metrics, EV/EBITDA, Price/Book Value and Price/Cash Flow multiples of the Meggit Plc are currently lower as compared to the corresponding multiples of the Aerospace & Defense Sector. It reflects, shares are undervalued as compared to the industry.

Key Risks

• The Company’s Energy business and Civil aerospace business are significantly impacted by the covid-19 related lockdown.
• The overall business of the Company could be affected by a change in regulations and government policies.

Recent News

On 24 August 2020, Meggitt announced the signing of a multi-million-pound contract with MODEC (MODEC Inc). As per the agreement, the Company through Heatric business will supply PCHEs (Printed Circuit Heat Exchangers) to Bacalhau FPSO (Floating Production Storage and Offloading) vessel.

Response to Press Speculation (released on 6 August 2020)

The Company’s trading performance stood in line with internal expectations and witnessed a recovery in the civil aerospace sector. Despite the early recovery, the Company believes COVID-19 related uncertainty remains. MGGT replied to speculation regarding equity funding and debt funding options and provided an update that it is reviewing multiple trading scenarios and other associated actions to reduce adverse change to the outlook of the industry. The Company’s liquidity and the financial position remained strong with committed facilities of £1,701 million providing headroom of £856 million as on 30 June 2020. The Company has also accessed additional liquidity under Covid Corporate Financing Facility launched by Bank of England.

One Year Share Price Chart

Daily Chart as of 1 September 2020, before the market close (Source: Refinitiv, Thomson Reuters)

Valuation Methodology

Technical Performance

From the technical standpoint, 14-day RSI is currently close to an oversold zone, which means there is a good potential for a short term rebound in the stock price.

Conclusion

The trading performance of the Company stood in line with the expectations and expected revenue to decline by around 15% versus H1 FY2019 data on an organic basis. The Company expects the market recovery in the civil aerospace sector as commercial airlines bringing more fleet back into service. MGGT expects significant free cash outflow in H1 FY2020 and will be reversed in H2 FY2020 to positive free cash flow for FY2020 before disposal. The Company believes risk and uncertainty will remain in H2 FY2020, and duration of the pandemic will impact the pace of recovery. The stock made a 52-week high and low of GBX 701.80 and GBX 196.15, respectively.

Based on the above rationale and support from the valuation as done using the above method, we have given a “BUY” recommendation for Meggitt Plc at the current price of GBX 270.60 (as on 1 September 2020, before the market close at 02:06 PM GMT+1), with high single-digit upside potential based on 14.90x Price/NTM Earnings (approx.) on FY20E earnings per share (approx.).

*All forecasted figures and Industry Information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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