Rolls-Royce Is Fast Becoming a British Calamity

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When the employees of Rolls-Royce Holdings Plc read that coronavirus lockdowns and home-working have ignited a technology boom, they could be forgiven for weeping.

The company makes the jet engines that power large passenger jets, which is one of the most technically complex engineering tasks known to man. And yet, most of Rolls-Royce’s products are grounded right now because hardly anyone’s flying. On Thursday the British manufacturer revealed the devastation inflicted on its business by Covid-19 travel restrictions: The 5.4 billion-pound ($7.1 billion) loss for the six months to June was one of the biggest profit shortfalls in U.K. corporate history.

A separate announcement that Rolls-Royce’s chief financial officer, Stephen Daintith, is jumping ship to Ocado Group Plc, an online grocer, compounded the gloom. It’s depressing that e-commerce is seen as a better destination than advanced engineering.

But you can’t blame Daintith for grabbing a parachute. Ocado’s shares have doubled this year, valuing the company at almost 19 billion pounds. Rolls-Royce — the pride of British manufacturing — is worth a quarter of that, having lost two-thirds of its value in eight months. Technology companies aren’t all equal in this market.

Incredibly, the 5.4 billion-pound loss wasn’t even the most troubling number in Rolls-Royce’s financial statement. Its balance sheet liabilities now exceed its assets by 8 billion pounds. This partly reflects big swings in the value of currency derivatives, rather than the underlying health of the business. Nevertheless, the massive net liabilities are by far the largest of any European company, according to Bloomberg data. It’s a terrible look for a company that spends years developing new engines, and then makes most of its money from long-term service agreements. Customers need to be confident that it will be around to meet those maintenance obligations.

While Rolls-Royce’s airline customers have their own pandemic problems, they’ve good reason to worry about the financial health of a key supplier. When the coronavirus crisis is over, Rolls-Royce will need to invest heavily in new technology that cuts carbon emissions. It doesn’t have the balance sheet to do that.  

There’s enough money to keep the lights on for the next 12 months, including 8 billion pounds of cash and undrawn credit facilities. But if there’s a second virus wave that prevents airlines from resuming long-haul flying, things might get tight in the autumn of 2021, when Rolls-Royce must repay or replace a 1.9 billion-pound revolving credit facility. The accounts include a warning of material uncertainty over whether the company can continue as a going concern if the aviation recovery takes longer than expected.

Rolls-Royce is doing all it can to strengthen its defenses. Assets valued at more than 2 billion pounds have been marked for sale. But this is hardly a seller’s market.  

The company continues to burn through cash, and its net indebtedness (including lease liabilities) is projected to rise to almost 6 billion pounds by the end of this year. Returning to a positive cash position will take years.

A large equity raise looks unavoidable to restore confidence. Unless the share price recovers a lot before then — which is unlikely — shareholders who don’t participate will be heavily diluted.

The group is considering industrial partnerships to share the burden of developing of its next-generation Ultrafan engine — Rolls-Royce’s engineering pride and joy. But if things get much worse, questions will be asked about whether it should remain an independent company in such a capital-intensive industry. A merger — whether with British defense manufacturer BAE Systems Plc or another engine maker — would be a less precarious path to recovery.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.

©2020 Bloomberg L.P.

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