Robust figures expected as the engine maker looks to expand into nuclear energy
By John Phelps

Sir John Rose, chief executive of Rolls-Royce, is set to confound pessimists on Thursday when he is due to deliver a robust set of trading figures in the face of the global downturn in the airline industry.

Interim results for the company, which employs 3000 in Scotland at its plants in Inchinnan and East Kilbride and at Dounreay in Caithness, will be accompanied by news of a bulging order book for the group's engines and confirmation of healthy cash balances as directors prepare for the heavy investment needed for a new venture into nuclear plant construction.

"Sir John is not the sort of person to shout good news from the rooftops and may well offer a slightly cautious note about prospects for the fourth quarter of the year," commented leading analyst Zafar Khan at Societe Generale. "But the overall message will be fine and we are buyers of the shares at current levels."

He believes that group profits will show an increase of more than 10% to about £425 million, boosted by particularly brisk business in the TotalCare engine maintenance service offered to major customers.

The update comes at a time when Rolls-Royce shares have been bumping along at just above three-year low points amid reports that many leading airlines are planning to mothball up to 20% of their fleets in response to a downturn in business caused by high fuel prices and the recession.

But directors will point out that the airlines are most likely to "retire" their older planes first while some two-thirds of aircraft using Rolls-Royce are less than 10 years old and use 10% less fuel.

At the same time, much of the recent order book has come from emerging nations and from the Middle East that have yet to feel the impact of the downturn in the tourism industry experienced in Europe and the US.

Rolls-Royce is understood to sell many of its engines at a loss but makes its cash through long-term service agreements where customers pay a monthly service fee based on engine usage.

Alongside the reassuring news on the dominant aircraft side, the directors should report brisk business on marine sales, including a breakthrough in the market for exploration vessels in both the Arctic and Antarctic, together with good demand for their generating equipment.

Brokers believe that cash balances are likely to show a fall on the near £900m recorded in February as a result of seasonal factors and a further injection of funds into group pension funds.

But the figures should indicate that the company is still enjoying a positive cash flow of upwards of £500m a year despite the costs of its hedging operations in currency markets to safeguard its dollar earnings.

The success of past dealings in these markets means that the group is still earning £54 on every $100 sales rather than a current worth of just £50.

Industry experts say that the group will need all of its financial expertise and cash if it is to make a splash in the nuclear energy market after last week's news that it intends playing a role in the creation of a new generation of power stations.

"They may have some expertise but there are enormous cash sums involved and a long time-lag before the cash finally changes hands," commented one observer. "A start-up business in this field would stretch the balance sheet of any company."

Rolls-Royce reckons it has a head start because it has had dealings with some 260 local companies in the supply chain through building and servicing the nuclear reactors used in the UK's nuclear submarine fleet.

And it can call upon the expertise of its nuclear engineers in Dounreay, Derby, France and the US who are already helping to advise the French EDF energy giant, which aims to build at least four nuclear power plants in the UK and has held takeover discussions with Scotland's British Energy.

The new Rolls-Royce operation will be based in Derby and will be aiming to benefit from the UK's nuclear power station building programme as well as seeking work on maintaining British Energy's ageing plants.

If all goes according to plan, the group hopes also to build up a presence overseas at a time when the worldwide market is expected to grow from the present £30 billion to £50 bn within 15 years.

Brokers believe the company intends to grow organically rather than looking for acquisitions, although they say that it may build strategic alliances and see potential benefits in a tie-up with the French Areva group, among others.