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Subsequent to Rolls Royce’s investor day, and the incremental “headwinds,” flagged by Warren East, we’ve updated our research on the company. We believe East has been aggressively bearish in his “headwinds,” which are not guidance, and ignore several hundred million in tailwinds the group will experience in 2016. With shares down by 20% since our original research note, which detailed operational initiatives we identified, we believe shares of Rolls Royce represent an outstanding opportunity in the next one, three, five and even ten years.
In a Nutshell:
Shares in Rolls Royce (RR/ LN) are down 20% since we first outlined our thoughts on Rolls. The new CEO, Warren East has flagged “headwinds,” the company will face in 2016 in order to set unreasonably low expectations that he can exceed from this point forward. As we’ve previously discussed, Rolls is going through a perfect storm where the legacy high-profit and cash-generative products are winding down, and the more efficient platforms in the Trent XWB and Trent 1000 are ramping up to become the company’s best performing engines in its history. Both of these programs are in a money-losing, cash-burn stage. This will be changing in the medium-term, yet most sell-side analysts and investors have shown they are unwilling to endure the turbulence in the transition, and have sold off shares in this high-quality duopoly to valuation levels more appropriate for auto manufacturers. Yet, engineering a wide-body engine remains one of the most complex engineering feats with very high competitive barriers to entry. Rolls manufactures the most efficient wide-body engine in the world in the Trent XWB, which is why it is doubling its market share in this segment of the industry. Because “visibility,” is low for sell-side analysts, we are getting this iconic business for an incredibly low valuation, and thanks to a depressed consensus, shares of Rolls are poised to do well over the next one, three, five and even ten years. Even perfect storms don’t rage forever.
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