JP Morgan cuts target on Rolls Royce amid host of concerns

Rolls Royce’s latest trading update created more uncertainty for investors in the opinion of JP Morgan and came on top of a host of concerns surrounding the outlook for the manufacturer.

In its wake, the broker slashed its estimates for earnings per share in 2015-2018 by 4%, 36%, 29% and 25% and pencilled in a £100m restructuring charge for 2016. The latter drove a 45% reduction in its estimate for the firm’s so-called ‘clean’ EPS that year.

Analysts David Perry and Malini Chauhan went on to explain that with the shares having fallen by 37% year-to-date, but the Bloomberg consensus for 2016 down by around 60% “the stock looks expensive to us”.

They also saw downside to the firms’ businesses across the board, whether it be as a result of the impact of weaker GDP growth on the industrial segment or reduced visibility on civil aero aftermarket trends.

Compounding the jet engine-maker’s woes, chief Warren East said he would not be providing medium-term guidance on 24 November when he is set to provide an operational review.

Then there is the no small matter that if the company wishes to maintain its dividend cover at three times earnings its dividend per share for 2016 would need to be slashed by about 6% from 2014 levels, JP Morgan said.

Among the other concerns dogging the shares were the potential for an EU investigation into the wide body aftermarket , the implications of new IFRS 15 accounting standard, potential new development programmes in civil aero and a structural loss of market share in the market for business jets.

Perry and his team reiterated their ‘underweight’ stance on the stock and cut their end-2016 target price to 405p from 630p.

RBC losing count ...

In parallel, RBC said the breadth and magnitude of the jet engine manufacturer’s profit warning had taken it by surprise.

“While weakness in Marine and softness in bizjet/RJ are not a surprise, the decline in widebody spares and the magnitude of the profit impacts in all three areas are a surprise,” analysts Robert Stallard, Steven Cahall, Krishna Sinha and Karl Oehlschlaeger said.

“We are starting to lose count [of the company’s profit warnings],” they added.

“Comments on the call suggest there isn't any indication at the stage to suggest these headwinds should reverse in 2017.”

Despite the drop in the stock’s price on 12 November, the shares were still changing hands at an estimated calendar year 2016 price-to-earnings multiple of 17.4 – for a 10% premium to the global aerospace average.

RBC reiterated its ‘sector perform’ recommendation and cut its target price on the stock to 540p from 750p.