UPDATE 4-Rolls-Royce defence warning unsettles sector

Thu Feb 13, 2014 10:30am EST

* Rolls-Royce expects return to growth in 2015

* Sees sharp drop in revenue, profit from Defence Aerospace

* Slow down comes after decade-long growth

By Brenda Goh

LONDON, Feb 13 (Reuters) - Britain's Rolls-Royce sent shivers through Europe's defence and aerospace sector on Thursday after it said U.S. and European spending cuts would halt profit growth in 2014, wiping almost 4 billion pounds off the firm's value.

Following the announcement that the group's decade-long profit growth was coming to an end, shares in Rolls Royce fell as much as 17.8 percent and led to a 2 to 3 percent slide in the shares of European peers BAE Systems, Finmeccanica and Airbus.

The drop in Rolls-Royce's share price represented the biggest one-day fall for the company in more than 13 years.

"We've defied gravity for a couple of years compared to many other companies and now we're having the impact come together in one year," said Chief Executive John Rishton on Thursday of the forecasted decline in defence revenues.

The 130-year-old company expects a 15 to 20 percent fall in revenue and profit from Defence Aerospace in 2014, and a modest reduction in revenue - but modest growth in profit - from the Marine unit. Overall this will result in a "pause" in 2014 overall revenue and profit growth following a strong performance last year.

Analysts had expected almost 8 percent growth in 2014 pretax profits, Thomson Reuters data showed. Rolls said it expects growth to return in 2015 as it ramps up production of aero engines.

"It's clearly shocked the market...It's a weaker backdrop than we have factored in previously. It's dragged everything else down," said Investec analyst Chris Dyett, who cut his profit guidance for Rolls-Royce by about 11 percent.

DEFENCE SPENDING

Defence contractors have found it difficult to forecast the impact of reduced defence spending by U.S. and European governments due to slow decision-making among lawmakers and the long-dated nature of some defence equipment contracts.

A two-year budget deal passed by U.S. Congress last year eliminated some uncertainty about funding levels, but analysts said that a solution for more cuts beginning in fiscal 2016 had yet to be found.

U.S. arms makers have recently tried to reassure investors by forecasting that U.S. military budgets would hit their low point in 2014 and 2015, with spending likely to stabilise and rise after that.

Rishton cited possible cuts by the United States on the size of its Lockheed Martin-built C-130 transport fleet, and the completion of delivery of two of its major export programmes - the Eurojet EJ200 engine to the Middle East and the Adour engine to India - as the reasons behind the expected decline.

An analyst who declined to be named said that Rolls's defence business in 2011-2013 was unusually buoyed by big export orders to Saudi Arabia and India. "Rolls Royce should have indicated that there was an element of bubble in that, that that was not sustainable."

Shares in Rolls-Royce, which fell to an almost 12-month low in earlier trading, were 17.6 percent lower at 996.75 pence at 1247 GMT. The shares have risen almost 800 percent in the last 10 years, when the group has enjoyed rapid growth.

DECADE-LONG GROWTH

Rolls-Royce has enjoyed strong profits and revenue growth over the last 11 years thanks to its civil aerospace unit, which generates about half of its sales. It has seen soaring demand for more fuel-efficient engines for planes made by Europe's Airbus and U.S. Boeing

On Thursday, it exceeded analyst expectations by posting a 23 percent rise in underlying pretax profits to 1.76 billion pounds ($2.92 billion), on a 27 percent increase in underlying revenues.

The company's 2013 and 2012 results were revised following accounting changes requested by Britain's accounting regulator.

Rolls-Royce said among its other units, it now anticipates modest growth in revenue and good growth in profit at its Civil Aerospace arm.

In Marine, which it had looked to strengthen last year by weighing a bid for Finnish ship and power plant engine maker Wartsila, a leader in building medium-speed engines, Rishton said they were continuing to look for ways to improve the unit's capability such as working on such engines in-house.

He declined to say if Rolls was looking for similar deals.

On costs, which Rishton focused on last year after describing them as "unacceptable", the company has made progress by cutting 11 percent of indirect headcount in 2013, and has been moving production away from high-cost countries, he said.

He also said Rolls-Royce was helping Britain's Serious Fraud Office "completely" with its probe into the firm's dealings in Asia. Two men were arrested on Wednesday by the anti-fraud watchdog in connection with the investigation.

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