Long-suffering shareholders of Rolls Royce (LSE: RR), Anglo American (LSE: AAL) and WM Morrison (LSE: MRW) have seen share prices at each company bounce back at least 25% from recent lows. Will these rallies prove to be short-lived bursts or do they signal the beginning of sustained share price growth?
Manufacturer Rolls Royce’s full-year results announcement saw dividends cut in half, the first cut in nearly of a quarter century, and profits down by 12%. Despite this poor news, the City has reacted warmly and sent the shares up 20% over the past weeks. In large part this was due to indications that the turnaround pan of new CEO Warren East, formerly of ARM Holdings, is beginning to bear fruit. Underlying revenue stabilised at a fall of 1%, no further profit warnings were announced, and an additional £150m to £200m in annual cost-cutting was targeted.
Rolls is in a very good position due to the duopoly in wide-body jet engines it shares with GE. These two industrial behemoths dominate a market forecast to double in the coming decades on the back of increased long-haul flights. However, in order to take advantage of this, Rolls needs to cut costs dramatically by simplifying supply chains, moving production in-house, and modernising production facilities. Management looks set to move down this path as production facilities for the new generation of Trent engines are increasingly mechanised and overhead costs are slashed. Rolls has a long way to go to bring margins up to GE’s level, but for long-term investors I believe the shares could appreciate significantly due to an enviable market position and room to increase profits by slashing costs internally.
Tough times
When the Chinese economy was growing over 10% per year and its appetite for commodities was voracious, Anglo American’s decision to diversify into a range of metals was lauded by investors. But now that prices for nearly every commodity are plunging, Anglo American has been left with a highly leveraged balance sheet and range of high-cost-of-production assets. Management has been forced to sell assets and suspend dividends to avoid increasing debt beyond an already staggering $13bn. This represents a gearing ratio of 37%, far higher than competitors such as Rio Tinto. Given this level of debt, several more years of necessary asset disposals ahead and the poor outlook for the commodities sector, I find it doubtful that shares of Anglo American will prove recent gains sustainable over the long term.
False dawn?
Grocer WM Morrison’s shares have bumped up recently on rumours that a competitor or private equity firm may be eyeing up the company as a takeover target. If untrue, the long-term outlook for the shares doesn’t look great. This is mainly due to a bleak future for the grocery industry. Low-cost rivals and online players such as Ocado and Amazon have led to price endless wars and dramatically falling margins. Morrisons’ operating margins were down to 2% over the last half year, a level at which shareholders will find little in the way of profits flowing back to them. With no catalyst for change on the horizon, I would be wary of investing in the sector at all due to low barriers to entry and changing consumer habits.
