Questor share tip: Rolls-Royce powered by JV buy out

Rolls-Royce
£10.26
Questor says Hold

Engine-maker Rolls-Royce topped the FTSE 100 yesterday following the news that it would buy out German engineering group Daimler’s 50pc stake in their power systems joint venture.

The British company has ample financial firepower to take full ownership of the three-year-old Rolls-Royce Power Systems (RRPS) business, with Daimler’s holding estimated to be worth £1.9bn.

Rolls said the transaction, which came from a “put” option it agreed with Daimler when they set up the joint venture, was expected to be completed within the next six months subject to the usual regulatory approvals.

“The deal will have low integration risk, and will be reasonably priced,” said Jonathan Jackson, head of equities at brokerage Killik & Co. "Rolls has ample liquidity to fund this purchase from existing cash and borrowing facilities.”

News of the deal was welcomed by investors who were stunned last month when Rolls unexpectedly said in its annual results that revenues and profits would be flat this year. Shares in the group had fallen 17pc since the warning but yesterday the shares added 1.6pc, closing up 17p at £10.43.

Celine Fornaro, research analyst at Bank of America Merrill Lynch, said the purchase of Daimler’s put option was “not a surprise” and “fully in line” with the strategy set out by Rolls chief executive John Rishton.

She said she expected 2014 to be a “difficult year with limited growth prospects” for Rolls but still raised her price target to £11.20, from £11.

“The management team remains focused on improving margins and cash generation to world-class standards as the company benefits from significant volume growth, especially in civil aerospace, but results won’t be seen before 2015,” Ms Fornaro said.

David Perry, analyst at JP Morgan Cazenove, also raised his target price on the company, up to £14.00 from £13.15, implying a 36pc upside.

“With Rolls-Royce now having 100pc control of RRPS, we believe that it can achieve some operational synergies as well when the deal closes,” he said.

He also raised his forecast for earnings per share between 2014 and 2016 by 2pc, 9pc and 9pc respectively.

However, not all analysts were so optimistic. Ben Fidler, analyst at Deutsche Bank, slashed his target price to 860p from £10.90 and maintained his “sell” rating on the company.

“We continue to see the risk-reward as unappealing. We have a number of overhanging concerns which in our view are still not adequately factored into valuation,” he said.

“Notably i) the slower pace of unit cost progress at civil aerospace ii) overhanging M&A risk driven by the CEO’s desire for a diversification strategy iii) accounting risk which has risen following recent events with the Financial Reporting Council.”

Meanwhile, Charles Armitage, analyst at UBS, argued the deal goes against the wishes of the shareholders and maintained a “sell” rating.

“We may be wrong, but it seems from the investor conversations we have had, the main rationale for [investing] in Rolls-Royce is the [prospects for its Trent series of engines] – diluting this through diversification reduces that rationale,” he said.

The shares are currently trading at price-earnings ratio of 15.3 and yielding 2.2pc. Despite the recent share price fall Questor says hold. Revenue and profits will be flat for this year and Rolls is not expected to see growth before 2015.