Exane downgrades Rolls-Royce to 'underperform'

Exane noted Rolls is the strongest sector performer year-to-date, with shares up 29% over three months, most likely thanks to new management’s continuing focus on execution and cost reduction.

The bank said first-half numbers were good but the main news was the announcement of the revenue recognition practices Rolls-Royce will adopt under IFRS 15, to be implemented in mid-2018.

“Under the new rules, earnings will be more closely aligned to cash flows, addressing one of investors’ previous key concerns. However, we think the changes raise several questions that need to be clarified.”

Exane said IFRS 15 will affect revenue accounting in most of the group’s businesses, with a major impact on the civil aerospace profit and loss.

It said the company has indicated that, contrary to previous statements, its accounting practices will converge towards the most conservative interpretation.

Exane has amended its earnings per share adjustments to better reflect underlying earnings and to anticipate some of the accounting changes.

“Cash remains cash, but we think that it will be difficult to ignore the (temporary) earnings contraction and resulting multiple expansion versus peers.

“A dedicated Teach-in in Q4 should shed more light on IFRS impacts (and possibly new cost-cutting targets). We expect the shares to be volatile ahead of this catalyst and downgrade.”

At 1150 BST, Rolls-Royce shares were down 2.5% to 755p.