Rolls-Royce Holdings Plc - Uncertainty remains high

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

Rationale for Valuation – Avoid at GBX 72.40

• As per trading multiples, the Company’s P/E, EV/EBITDA, and P/CF multiples, reflecting overstretched valuations as compared to Aerospace and Defence industry.
• The Company has accelerated cost mitigation plans to reduce free cash outflow in the second half of the financial year 2020.
• The Company has identified several potential disposals that are expected to generate proceeds of over £2 billion, including ITP Aero and a number of other assets.
• The Company’s profitability metrics are in negative territory, whereas the industry has been delivering positive fundamentals.
• The stock has underperformed the index (FTSE 100 index) during the last one-year period and delivered a negative return of 70.51%.
• On the liquidity front, Rolls-Royce Holdings Plc’s current ratio of 1.02x was lower than the industry median of 1.10x.
• From the technical standpoint, the 200-day simple moving average price is currently at GBX 118.31, which is higher than the current price and reflecting a downtrend in the near term.

Key Risks

• 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.
• 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.

Recent News

On 15 October 2020, the Company announced that it has successfully priced an offering of three tranches of senior unsecured notes, which comprises in US dollars, euros and sterling to raise gross proceeds of around £2 billion.

Financial Highlights (for the six months ended 30 June 2020 (H1 FY20), as on 27 August 2020)

(Source: Company Website)

• The Company demonstrated a strong balance sheet, with a cash balance of £4.2 billion and CF (revolving credit facility) of £1.9 billion.
• Rolls-Royce expects free cash outflow of around £1 billion in the second half of FY2020, driven by the acceleration of cost mitigations.
• It also announced term loan backed by UKEF (UK Export Finance) for £2 billion in July 2020.
• 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, and reported operating loss stood at £1.8 billion.

One Year Share Price Chart

 (Source: Refinitiv, chart created by Kalkine Group)

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

Conclusion

RR believes business recovery will commence by the end of H2 FY20, based on a gradual recovery in civil aviation. FY20’s underlying revenue is projected to be 25%-30% lower than FY19. It expects most of the Power Systems end markets will recover by the end of FY21, and revenue will reach normal levels in FY22. Further, it is targeting to return to positive free cash generation by H2 FY21 and free cash outflow in FY21 will be significantly lower versus FY20. The Company expects large engine deliveries to increase gradually beyond FY2022. With cost-reduction measures, RR is expecting to generate the cash flow benefit of over £1 billion in FY20. The Company expects that the market would remain uncertain despite the economic recovery and easing of travel restrictions. On 29 October 2020, the share price was down by around 14%, due to the wake of increased lockdown restrictions announced in France and German. The stock made a 52-week low and high of GBX 34.59 and GBX 271.79, respectively.

Based on the headwinds faced by the Company, we have given an “Avoid” recommendation on Rolls-Royce Holdings at the closing market price of GBX 72.40 (as on 29 October 2020).

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

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