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Rolls Royce – Jam tomorrow after all

Rolls Royce announced their full year results today and they were very good – underlying profit before tax up 23% and revenue up 27%. The order book also grew by 19%. But the share price promptly dropped by 15% in morning trading.

The reason for the fall was simply that the adjusted earning were below expectations, and there were some very negative comments from the CEO about the expectations for 2014. To quote: “we expect a pause in our revenue and profit growth, reflecting offsetting trends across the business“. Growth will only resume in 2015, he forecasts. Later it is made clear that underlying Group revenue and profit will be flat in 2014. That’s very different to what analysts were forecasting for 2014.

The main reason for the decline is a 15% to 20% reduction in revenue from the defence sector, no doubt due to Government spending reductions in that area.

The fact that two people were arrested by the Serious Fraud Office the previous day in relation to long standing bribery allegations by Rolls-Royce in Indonesia probably did not help sentiment towards the shares. Although the events referred to took place before the new Bribery Act came into force, there is concern that if the allegations are shown to have some substance (and Rolls-Royce denies them), then the company might have to reach some kind of settlement with the legal authorities. That might be expensive.

But surely the reaction in the share price is rather overdone. After all there are not many large and mature businesses that have achieved the rates of revenue and profits growth that Rolls-Royce has achieved. Aero-engines are still a growth market and Rolls-Royce is a technology leader in that segment. The company expects growth to resume in 2015 and the order book certainly looks healthy. In the meantime the company is working on the cost aspect of the business.

So one might summarise these results by saying it’s jam tomorrow rather than jam today after all. But as usual the market seems to be taking a very short term view of this company’s prospects.

Roger Lawson

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