Wednesday, December 30, 2015

Rolls-Royce eyes possible re-entry into smaller plane market

Warren East, CEO of Rolls-Royce, beside airplane engines at the company aerospace engineering and development site in Bristol.

The chief executive of Rolls-Royce said the prospect of making engines for narrow-bodied aircraft was very attractive but warned that the cost of re-entering the market would be significant.

The comments from Warren East, who took over as boss of the manufacturing group in July, have been interpreted by analysts as meaning that the company would only return to the booming market for planes that carry up to 200 people, through a major corporate deal.

There has been speculation in the City that Rolls-Royce could look to buy back into a joint venture with its rival Pratt & Whitney, which it exited in 2012. However, in return the US company would likely seek a major stake in Rolls-Royce’s wide-bodied business, which makes engines for the Airbus A380 superjumbo.

Rolls-Royce is struggling after issuing five profit warnings in less than two years, and its share price has fallen by almost half since late April. The Derby-based group has blamed its profit warnings on a collection of factors, including falling demand for corporate jets and the slump in the oil price hurting customers in the energy industry.

However at the centre of its troubles is the decision to pull out of making engines for narrow-bodied aircraft to focus on wide-bodied planes such as the A380, the A350XWB, and the Boeing 787 Dreamliner. Since then orders for wide-bodied aircraft has slowed, while the narrow-bodied market is booming thanks to the demand for the A320neo and the Boeing 737 Max. This means that Rolls-Royce’s rivals General Electric and Pratt are outperforming the British company.

East made his comments about the market for small planes in a presentation to investors at the end of November. In the presentation East warned that there was a “significant cost of re-entry so [the] business case would need to be compelling”. However, he also said that Rolls-Royce was still making money from servicing engines on older narrow-bodied planes and could develop new engines for the generation of planes that will replace the A320 and the 737.

These new aircraft will not enter service until around 2030, and Rolls-Royce said it would make a decision on whether to try to develop engines for those products in the early 2020s. But East insisted that Rolls-Royce does not have to re-enter the narrow-bodied market.

“The big question I think, and there’s been a lot of debate that I’ve heard since joining the business, is so ‘what about narrow-body in the future’ and ‘surely you have to be in narrow-body in the future’? I think the answer is no, we don’t. We don’t have to be in narrow-body in the future. It’s a great opportunity at some stage when it arises. But right now, there isn’t an opportunity. There is no opportunity for us to enter this business until the early 2030s. There’s maybe a little bit of discussion about a sort of quasi wide-body opportunity maybe five years ahead of that.

“So this is actually not something that we should be wasting our time on right now in terms of debating. We don’t actually need to do anything right now other than enjoy the aftermarket [engine servicing] revenue and work on making sure that we’re earning that aftermarket revenue as efficiently as possible and maximising the profit opportunity on that over the next several years. Developing our technology and taking advantage of an opportunity if and when an opportunity arises, that is essentially the position for now on narrow body.”

After pulling out of narrow-bodied planes, a decision made by former boss Sir John Rose, Rolls-Royce has been able to focus on wide-bodied aircraft, which typically hold 250 people or more. It is on course to claim a 50% share of the market by 2020, up from 30% today. The company is the exclusive supplier for the A350. However, pulling out of the narrow-bodied market has hurt Rolls-Royce’s sales volumes, leaving its factories short of work. East is attempting to cut costs by up to £200m a year in a bid to get the company back on track.

The level of concern about the future of Rolls was underlined this month when it emerged the government has drawn up contingency plans to nationalize its nuclear submarine business or force it to merge with defence manufacturer BAE Systems in the event the company’s performance worsens. The government has a golden share in Rolls-Royce meaning it can block any takeover and prevent a foreign investor owning more than 15% of the company. ValueAct, an activist investor based in California, has built a 10% holding in Rolls-Royce and wants a seat on the board.

On top of Rolls-Royce’s operational problems, it is mired in a Serious Fraud Office investigation about bribery allegations in China, Indonesia, and other parts of the world.


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