Shares in Rolls–Royce (LSE: RR) leapt over 13% in early trading this morning as the company released an encouraging set of expectations-beating, full-year numbers to the market. Having been on a negative trajectory since November, is today’s bounce a sign that investors should now consider adding the stock to their portfolios?
Soaring profits
Despite encountering technical problems relating to its Trent 1000 engines over the reporting period, underlying revenue rose 6% to just over £15bn, including a 12% increase in service revenues at the company’s Civil Aerospace arm.
Perhaps most positively, underlying pre-tax profit soared 25% higher to £1.07bn thanks to a “strong contribution” from the company’s Power Systems unit. As a consequence, free cash flow hit £273m — a 173% improvement on the £100m achieved at the end of 2016.
On the flip side, net debt rose £225m to £520m, partly as a result of financial penalties issued by investigating bodies. With another £378m in fines still due to the Serious Fraud Office, it’s perhaps no surprise that dividends were kept steady at 11.7p per share.
Looking ahead, the £15bn cap now predicts high single-digit revenue growth in its Civil Aerospace and Power Systems arms over 2018. Free cash flow is expected to further improve and sit at around £450m by the end of the year, with a target of £1bn set for “around 2020“.
Having already secured £200m in savings, 2018 will be another year of restructuring for the company. Back in January, Rolls announced that it intended to reduce its five business units into three “tightly focused operating businesses“. In addition, the company declared that it would continue to cut costs and improve performance by adopting a “simplified staff structure“. Further updates on this will come later in the year.
While much work still needs to be done before the turnaround is complete, today’s numbers will surely help to reassure those who stayed loyal to the company over the past few years. Given that its stock already trades on a heady 26 times forecast earnings and offers little in the way of dividends, however, I’m inclined to suggest that Rolls Royce — a quality business though it may be — is perhaps not a great investment at the current time.
Buy for the income
While not without its own issues, I think £19bn defence giant BAE Systems (LSE: BA) is perhaps a better buy, particularly for those looking to generate a reliable income from their portfolios.
Sales hit £19.6bn over 2017 with underlying earnings before interest, taxes and amortisation (EBITA) rising 4% in constant currency to just over £2bn.
Describing a situation not dissimilar to that at Rolls, CEO Charles Woodburn stated that the company began 2018 with a “streamlined organisation” which should provide “a solid foundation for medium-term growth“. With it looking increasingly likely that US defence budgets will be hiked (and the country accounting for a significant proportion of the BAE’s sales), the future looks anything but bleak. The fact that BAE is confident of securing more orders for the Eurofighter Typhoon also bodes well.
Changing hands at just 13 times earnings, stock in BAE is expected to yield 3.9% in 2018. While the pension deficit remains a concern, the fact that it also managed to reduce its debt burden over the last year to the tune of £790m suggests payouts will continue to rise going forward.
