by Richard Pettibone, Aerospace & Defense Companies Analyst, Forecast International.
It has been a rough couple of years for Rolls-Royce. Sales are declining, and a new management team has been put in place as the company rides out the current storm.
While 2015 sales were relatively flat with 2014’s at GBP13.7 billion, net income dropped 12 percent to GBP1.08 billion from $1.23 billion in 2014. The declines were attributed to ongoing Russian sanctions, an anemic economic environment, and a major contract loss – some GBP2.6 billion of work due to the cancellation by Emirates of its order for 70 Airbus A350s.
In attempting to right this ship, new CEO Warren East wasted no time in ordering a review of Rolls-Royce’s operations. The result found several problems, including high fixed costs, dated processes, bloated management, and an inability to rapidly respond to market dynamics.
In response, the company has initiated a series of measures aimed at saving some GBP150 million to GBP200 million a year by 2017. These measures include layoffs of some 2,600 workers (most of which have been completed), cutting management payrolls around 20 percent, and getting its Marine division back on track via cost savings and additional job cuts.
It will take a little while for these changes to ripple through the organization. Profits will continue on a downward trend before bottoming out this year. After that, the restructuring efforts should take root, with results improving in the Marine division, and new engine programs such as the Trent XWB ramping up production. Farther out, growth in aftermarket support will help fuel sales in the latter part of the decade.
The need for a turnaround is acute. According to news reports, the U.K. government is investigating contingency plans to maintain sovereignty over its nuclear submarine industry base. Options on the table could include a merger with BAE Systems or, more drastically, a nationalization of the nuclear powerplant operations if performance continues to decline.
While the loss of the Emirates order was a blow, the company still has a sizable backlog brought on by the recent boom in civil jetliner orders. Development of new engines is complete and the production phases are now underway, which means this large backlog will begin to be realized. In addition, new, more efficient facilities have been opened in the U.S. and U.K. that should boost productivity and improve the firm’s competitive position.
One of the vulnerabilities facing the company is that its current programs focus on widebody aircraft, while the market wants narrowbodied planes. In the widebody market, engine manufacturers are tweaking existing designs to deliver improved performance rather than pursuing clean-sheet development.
Rolls-Royce did have a foothold in the narrowbody market via its shareholding in International Aero Engines (IAE). However, it sold its stake to Pratt & Whitney for $1.5 billion. With the narrowbody market forecast to be strong in the years ahead, Rolls-Royce will be focusing on developing new technology. The question now is whether the firm will go it alone or look to partnerships on such a project – both are areas in which CEO East has expertise.
Looking ahead, services and support are expected to become avenues of growth for the company. Both the U.S. and U.K. are expanding the use of professional service providers to supplement their armed forces – so much so that operations and maintenance budgets are expected to rival production budgets.
The new management team has its work cut out for it as it deals with headwinds in this era of merciless economic markets. As the old curse intones, the company is living in interesting times.
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