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Rolls-Royce shocks shareholders with $1 billion-pound profit loss


LONDON—Rolls-Royce Holdings Plc said 2016 earnings will take a 650 million-pound ($ 1.3 billion Canadian) hit from lower demand for aircraft engines and overhaul work, extending a sequence of profit warnings that’s battered the company for two years and sending the stock down the most since 2000.

Pre-tax profit for 2015 will also be at the “lower end” of a forecast range of 1.3 billion pounds to 1.47 billion pounds, and the London-based company plans to review its policy on shareholder payments, it said in a statement Thursday. Rolls- Royce shares tumbled as much as 22 per cent.

Chief Executive Officer Warren East, who has been reviewing Rolls’s businesses since taking over in July, said he’ll introduce a restructuring program aimed at delivering savings as high as 200 million pounds a year from 2017. Details of plans to simplify its organization and management will be announced Nov. 24.

“The outlook for 2016 is very challenging,” East said on a conference call. “The speed and magnitude of change in some of our markets, which have historically performed well, has been significant and shows how sensitive parts of our business are to market conditions in the short-term.”

Inflexible

Rolls-Royce, which investors had been counting on to deliver an upswing in earnings from a record backlog for its Trent engine range, fell 147 pence to 520 pence, the biggest drop since Aug. 24, 2000, before trading 18 per cent lower at 547.50 pence as of 9 a.m. in London.

East, who previously ran world-leading semiconductor designer ARM Holdings Plc, said his review suggests Rolls’s biggest problem lies not so much in a portfolio that includes power equipment and ship engines as an inflexibility that make its unable to respond quickly enough to changing market demands.

“The fixed costs in this business are simply too high, so that small, relatively modest changes in the top line driven by market conditions just make too big an impact on our profit,” he said. “It’s up to us to be more able to deal with these situations.”

East’s comments come as a further blow to a business that was regarded as Britain’s biggest industrial success story, recovering from bankruptcy to become a poster child of Margaret Thatcher’s privatization drive and take on the likes of General Electric Co. The CEO said he sees no quick fix, effectively writing off a recovery before 2017, when the results of a restructuring plan begin filtering through.

The earnings “headwind” for 2016 predicted today compares with a figure of 385 million pounds estimated on July 6, days after East took over.

The revelations regarding Rolls-Royce’s organizational malaise suggest the company may be headed for a “classic aerospace and defence near-death experience” that could see its shares drop 80 per cent from the peak, Agency Partners analyst Nick Cunningham said.

That came as a shock to investors who had been expecting East to focus his attention on re-evaluating the London-based company’s diversified business portfolio away from power equipment and marine turbines to focus on a record aero-engine backlog.

The meltdown could spill into the U.K.’s political arena as doubts are cast over job security. Rolls employs more than 50,000 workers, many of them in highly skilled roles in economically vulnerable parts of the country. The political reaction was muted with details on East’s restructuring coming only later this month. The Department for Business, Innovation and Skills had no immediate comment when contacted.

‘Capacity Management’

Earnings next year will be hurt by “sharply lower” sales of corporate jets powered by Rolls engines, together with a more sluggish maintenance market both for those aircraft and bigger regional jets, accounting for 100 million pounds of the increase. Reduced utilization of older wide-body engines will wipe out 150 million pounds beyond prior projections.

“This is essentially capacity management by some of our customers,” East said, adding that even with a lower oil price that’s made the retention of older jets viable by cutting fuel expenses, “If you happen to have already bought an aircraft with more-efficient engines, then you’re going to use it.”

Rolls-Royce is also being impacted by a further deterioration in the market for engines that power marine vessels used by the oil industry, which will weaken profit by an extra 100 million pounds.

Shares of Rolls-Royce have slumped 36 per cent this year following a decline of 32 per cent in 2014, reducing the company’s market value to 10 billion pounds.

Credit-default swaps insuring the company’s bonds against losses jumped to the highest since April 2013, a sign that perceptions of credit quality have deteriorated. The contracts rose 6 basis points to 81 basis points in the biggest jump since January, according to data compiled by Bloomberg.

With files from Katie Linsell.

TORONTO STAR | BUSINESS

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