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Rolls-Royce Holdings PLC Nosedives On Profit Warning

rollsroyceShares in Rolls-Royce Holding (LSE: RR) (NASDAQOTH: RYCEY.US) are down by 8.5% at 860p as I write, after the firm issued a ‘guidance warning’ in which it slashed revenue forecasts for 2014 and 2015.

Russian sanctions hitting UK firms

Rolls says that underlying revenue for 2014 is expected to be 3.5% to 4% lower, having previously guided the market to expect flat revenue this year. The firm says that economic conditions have worsened over the last few months and that Russian trade sanctions have led to a number of delayed or cancelled orders, although these have been partially offset by cost-cutting.

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As a result, Rolls is maintaining its forecast for flat underlying profits in 2014, excluding around £80m of currency and exceptional costs. However, free cash flow is now expected to fall to £350m, 55% below the firm’s previous guidance of £780m.

This is likely to mean that Rolls’ dividend won’t be covered by free cash flow this year, although with net cash on the balance sheet, I don’t think there’s any risk of the dividend being cut, unless trading conditions become much worse.

Worse to come?

Today’s announcement is the second time this year that Rolls has felt the need to adjust market expectations to a more cautious outcome. As a result, the firm’s shares are now down by 32% in 2014, putting the shares on a fairly undemanding 2014 forecast P/E of 13.4.

However, profit warnings often come in threes, and although neither of this year’s two guidance updates have officially been profit warnings, I firmly believe that today’s message is a profit warning in all but name.

I wouldn’t be surprised if a third, open profit warning follows today’s announcement, later this year.

This could happen on 13 November, when Rolls is due to update the markets on its performance in the third quarter: by this time, the company will have a pretty good idea of what full-year profit and revenue will be.

Buy now?

I would wait a little longer before buying Rolls shares. Although a forecast P/E of 13.4 isn’t overly expensive, it isn’t obviously cheap either.

The outlook for 2015 is now far more uncertain, with Rolls guiding for flat revenue and falling profits, rather than a return to growth. This outlook justifies a discount to the wider market, in my view, which suggests a target buy price of around 750p.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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