Problems with a major contract and new accounting rules signal more turbulence ahead for the troubled company, says Ben Judge.
Rolls-Royce, the “engine-maker with a penchant for profit warnings”, as Chris Bryant on Bloomberg puts it, is in trouble again. Just last week, one of its major customers, Emirates, said that there are “some issues” with the 217 Trent 900 engines it has ordered for its fleet of 50 Airbus 380s. Worth $9bn, this is Rolls-Royce’s largest order on record. Rolls is currently in talks to resolve the issue, but Emirates CEO Tim Clark won’t be fobbed off: “We want the engines as promised in the contract,” he said.
The bust-up with Emirates came just a day after Rolls CEO Warren East told investors the company would be changing the way it accounts for profits. Under the new IFRS 15 accounting standard, which will come into effect in 2018, last year’s earnings would have been £900m less than the £1.4bn originally reported. Rolls’s civil business “isn’t very complicated”, says Bryant. “It sells plane engines and maintenance packages.” But its accounting practices are “barely comprehensible”. It makes a loss when selling an engine, but recoups that with the profit on the service contract.
“For over ten years”, says Nina Trentmann in The Wall Street Journal, Rolls-Royce was able to “compensate for losses by booking some of the services revenue early”. Under the new standard, the loss attributed to the sale must be recognised immediately, and revenue from the maintenance contract “cannot be booked until the actual work takes place”. This will “weigh on earnings through 2020”.
The announcement was “a disastrous attempt to explain itself to the City”, say Alan Tovey and Christopher Williams in The Daily Telegraph. Analysts are now “struggling more than ever to put a value” on the company. They quote one, Zafar Khan from Société Générale, as saying Rolls should now be considered a “concept stock”, more akin to the dotcom stocks of the 2000s. “People buy stocks based on certain valuation yardsticks such as the price/earnings ratio,” he said. But under the new accounting measures, “you just can’t put a value on it”.
Although the new rule “has no impact on the fundamentals of the business or its cash flow”, says Peggy Hollinger in the Financial Times, “it will force investors to rebase their expectations” of stated profit levels. And while those will have to be “rebased”, it does have the advantage of “more accurately [reflecting] the cash coming into the business”, says Hollinger.
“Profit’s an opinion, while cash is a fact,” says Bryant. Rolls-Royce “had far too high an opinion of itself in the past… Perhaps it’s time shareholders adjusted their view too.” Many already have – the shares have fallen by more than 10% in the last week.
Lloyds stands on its own feet and goes shopping
Lloyds Banking Group is said to be “in pole position” to buy MBNA, Bank of America’s UK credit card business. If the £7bn deal comes off, it will be Lloyds’ first acquisition since being bailed out by the taxpayer seven years ago. The public stake in the bank now stands at under 8%.
Just a month ago, Lloyds looked to be backing out of the deal after “an unexpected £4bn bill for past mis-selling of payment protection insurance” forced Lloyds to think again, notes Aimee Donnellan in The Times. But according to insiders, Lloyds edged ahead of US private-equity group Cerberus in the race for MBNA after BofA “agreed to indemnify the buyer if PPI costs rise above a fixed cap”. Penalties for the PPI scandal have already cost Lloyds £17bn.
Still, while buying MBNA is an “obvious move to make”, bringing Lloyds’ share of the credit card market up from 15% to more than 25%, the deal looks “ill-timed”, says Patrick Jenkins in the FT. With default rates and central-bank interest rates at record lows, “rates and defaults are only going to rise” from here.
The uncertain outlook for the UK economy, the falling pound and “resultant inflationary pressure” are “bad news for customers’ ability to service their debts”. Lloyds says its existing portfolio and MBNA’s are “low risk”, but if the deal does go ahead, “that view is likely to be tested”.
City diary
• Coming from running a “sexy telecoms business in the Caribbean” to “mulling the margins on bog cleaning in Barnsley”, Phil Bentley must wonder what he’s let himself in for, says Jim Armitage in the Evening Standard. Bentley takes over from the “prickly peer” Baroness Ruby McGregor-Smith at outsourcing group Mitie, where the operating margin has slumped from 5.2% to 3.2% in the past year, and the share price has fallen by more than 30%.
Despite McGregor-Smith’s outgoing “kitchen sinking”, cleaning the company up will be a ”long and mucky task”, says Armitage. “Steer clear until the new Mr Mop has got his Marigolds on.”
• Philipp Humm has had a long and illustrious boardroom career. He was chief executive of T-Mobile in the US before moving to Vodafone Europe, where he was downsized in July this year. Humm took up art classes and, under the name Philipp Rudolf Humm, has forged a new career as a painter. This week his first solo exhibition, “Being & Time”, opened at London’s Riflemaker Gallery. According to The Capitalist in City AM, Humm’s work “draws on the Renaissance and pop art”, with Humm describing himself as a “neo narrative figurative painter”.
• French luxury goods makers LVMH and Hermès are “embroiled in a murky tale of espionage”, says Adam Sage in The Times. Sixty-year-old Bernard Squarcini, the former head of DCRI, France’s equivalent of MI5, is under arrest, accused of plotting to spy on ten members of the Hermès family at the behest of LVMH.
Squarcini had started his own intelligence-gathering business in 2012. The plan to spy on Hermès cost an etsimated €2m. This is just the latest skirmish in a “handbag war” between the two companies that dates back to 2010, when the billionaire owner of LVMH, Bernard Arnault, acquired a 23.2% stake in Hermès.