Rolls-Royce Holdings PLC – Operating in difficult and uncertain trading conditions.

Rolls-Royce Holdings PLC (LON: RR.) is a FTSE 100 listed Industrial Technology Company, which caters to the planet’s power needs. It has over 400 airlines customers, 5,000 power and nuclear customers in more than 150 countries.

Investment Rationale – Avoid at GBX 117.00

• From a trading multiple perspective (EV/EBITDA, EV/Sales, and Price/Cash Flow), the stock seems overvalued as compared to the Aerospace and Defense industry.
• The Company’s Gross Margin, EBITDA Margin and Net Margin are in negative territory, whereas the industry has been delivering positive fundamentals.
• From the technical indicator, 14-day RSI (55.20) is not supporting the upside potential.
• The stock has given a negative return of ~51.68% in the last one year, whereas FTSE 100 has taken a hit of ~0.68%.
• The year-to-date flying hours of Civil Aerospace large engine was merely 42% of 2019 level.

Risk Assessment

• The Covid-19 pandemic can have an adverse effect on RR’s business operations as it can lead to delay in contracts, reduced spending by the major defense and commercial customers, cancellation of obtained contracts, and lack of funding availability.
• The overall business of the Company could also be affected by a change in regulations and government policies.
• The Company is exposed to several market risks, some of which are of a macro-economic in nature such as, fluctuations in foreign currencies, oil prices, and interest rates.

Trading Update (as on 11 December 2020)

• The Company has confirmed at least £1 billion of near-term cash cost mitigations for FY20. It is on track to deliver the targeted £1.3 billion cost savings by FY22.
• The Defence division remained resilient with strong order cover for FY21.
• The Power Systems end markets seeing some early signs of improvement.
• The Company completed a £5 billion package in November to increase resilience, strengthen the balance sheet and support long-term strategy.

One Year Share Price Chart

 (Source: Refinitiv, chart created by Kalkine Group)

Valuation Methodology: EV/Sales Approach (NTM) (Illustrative)

Conclusion

Although the Company started FY20 with positive momentum, the Covid-19 pandemic severely impacted the performance in H1 FY20 and medium-term projections. The most pronounced hit was observed in Civil Aerospace segment though Power Systems was relatively less impacted. Adjacently, Defence segment remained resilient without much material impact; however, industrial markets were suppressed. Similarly, ITP Aero was affected as severely as Civil Aerospace. With cost-reduction measures, RR is expecting to generate the cash flow benefit of over £1 billion in FY20. Notwithstanding, the Company did not recommend a final dividend payment of 7.1 pence per share and did not approve an interim shareholder payment for H1 FY20.

In respect to guidance, it is targeting a positive cash flow during H2 FY21, and by FY22, the Company should return to an annual free cash flow of £750 million. Stock 52 week High and Low were GBX 245.64 and GBX 34.59, respectively.

Given the heightened level of uncertainties, we recommend a “Avoid” stance on Rolls-Royce Holdings PLC at the closing price of GBX 117.00 (as on 11 December 2020), while we look forward to reviewing the upcoming catalysts and reinvest at the right price for value investing.  

Bellway PLC – Having considerable cash resources to maintain a solid operational structure.

Bellway PLC (LON: BWY) is a FTSE 250 listed residential property developer. It is engaged into housebuilding and caters the population across England, Scotland, and Wales regions. The Company sell their homes through two main brands, namely Bellway and Ashberry.

Rationale for Valuation – Hold at GBX 2,718.00

• The Company has decent fundamental metrics as it has maintained a Net margin above 15% for the last five years and ROE (return on equity) above 8% for the last two years.
• Bellway recorded a lower debt-equity ratio of 0.01x (H1 FY20) against the industry median, which reflects that BWY is less leveraged as compared to the industry.
• From the technical standpoint, 14-day RSI stood at 30.69, which is supporting the upside movement.
• The Company is witnessing a strong underlying demand for new homes and operating with a robust balance sheet position.
• The order book is substantial and with a higher number of completions already achieved.

Key Risks

• The next phase of lockdown in the wake of the second wave of COVID-19 outbreak could result in lower demand, a shortage of labour and shut down of operations.
• Consequently, consumer spending is likely to reduce in the near to medium term, which might dent the demand.
• The performance is also subject to the change in government policy and planning regulations as it can affect the value of land purchasing.

Trading Statement relating to the 17-week period from 1 August 2020 to 29 November 2020 (as on 11 December 2020)

• There was a 6% increase in the reservation rate to 210 per week (1 August 2019 to 24 November 2019 – 199 per week), which reflected strong underlying demand for new homes.
• The forward sales position is substantial, with an order book comprising 6,186 homes and a value of £1,766.7 million.
• The Company has also maintained a strong balance sheet with net cash of £242.9 million, and having and substantial capacity to invest further in land.
• The Board recommended a final dividend of 50.0 pence per share in respect of the year ended 31 July 2020.
• As of 29 November 2020, net cash was £242.9 million, which reflected a strong balance sheet position.

One Year Share Price Chart

 (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Conclusion

The interest rates remained low, which aided affordability and the temporary stamp duty holiday continued to provide valuable support to the whole housing market. The Company witnessed a solid platform for FY21 with a strong forward order book. Further, Bellway has shown a strong balance sheet and a rising rate of private homes. The rising demand for housing is supported by the ‘Help to Buy’ scheme. According to the market, the UK housing market started to show signs of revival. Overall, the Company has substantial resources in place to navigate through the challenging phase of the pandemic and generate long-term value for shareholders. The stock made a 52-week high and low of GBX 4,336.00 and GBX 1,735.50, respectively.

Based on the decent growth prospects, and support from the valuation as done using the above method, we have given a “Hold” stance on Bellway at the closing market price of GBX 2,718.00 (as on 11 December 2020), while we look forward to reviewing the upcoming catalysts.

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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

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