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Rolls-Royce Decade-Long Growth to Stall as Defense Cuts Bite

Feb. 13 (Bloomberg) -- Rolls-Royce Holdings Plc said sales won’t grow this year for the first time in a decade as lower demand for defense equipment cuts into civil-aviation sales, sending the stock tumbling the most in more than 13 years.

“We expect a pause in our revenue and profit growth, reflecting offsetting trends across the business,” Chief Executive Officer John Rishton said today as the London-based maker of aircraft engines reported full-year earnings. The causes are “particular to this year,” he told analysts.

The muted outlook is a rare miss for Rolls-Royce, which has rewarded investors with a near uninterrupted stock-price growth for a decade, coupled with steady earnings and dividends. The setback adds pressure on Rishton to tackle costs, which the CEO said remain too high even after cutting headcount last year, and to reignite growth at units outside the civil-aviation market.

Pretax profit excluding hedging and some one-time items advanced to 1.76 billion pounds ($2.9 billion) last year, while sales rose 27 percent to 15.5 billion pounds. The stock dropped as much as 12 percent, the most since Oct. 2008, wiping about 2.5 billion pounds off the company’s market value.

Flat Outlook

“Rishton was looking to create some internal pressure for change and improvement, and the irony is that this has got to help,” said Nick Cunningham, a London-based analyst at Agency Partners, who recommends investors sell the stock. “It is not the ideal way of going about it.”

Rolls-Royce slumped as much as 215 pence, or 18 percent, to 995 pence in London, the lowest in a year. Before today, Rolls had declined 5.1 percent this year after rising 46 percent during 2013, its best annual return since 2005.

Profit in relation to revenue fell to 11.8 percent from 12.2 a year earlier. Cash inflow fell to 359 million pounds pounds after reaching 1.1 billion pounds in the prior period, after Rolls-Royce disposed of its share in an engine joint venture that powers Airbus A320 narrow-bodies.

Savings have advanced well in the marine and energy areas, Rishton said. Savings in civil aerospace should start to materialize this year.

This year’s “flat” outlook reflects a decline of defense sales of as much as 20 percent as contracts in Saudi Arabia and India reach the end of their life. The company is now experiencing a stronger fallout from defense cuts than previously, the CEO said.

Medium-Speed Diesels

Marine revenue should also decline as investments are deferred, Rishton said. Civil aerospace, the largest unit, should see modest revenue and good profit growth, Rolls-Royce said. Free cash flow should match the performance last year, it said.

Rolls-Royce’s civil aerospace sales advanced three percent last year to account for about 43 percent of total turnover. Defense sales advanced 7 percent, while the unit’s order bookings contracted 21 percent.

As Rishton continues to reshape Rolls-Royce’s portfolio, he explored a bid for Finland’s Waertsilae Oyj, a maker of marine engines, before talks were abandoned. Acquiring Waertsilae would have strengthened Rolls-Royce’s portfolio in medium-speed marine and land engines, Rishton said.

“We believe we need to strengthen our medium-speed diesel engine businesses,” he said, adding Rolls-Royce’s activities are “relatively small.” The company is making internal investments to expand the product line, Rishton said.

Rishton would not comment on acquisition plans beyond saying the company would continue to look for growth opportunities in both its gas-turbine activities, such as those powering airliners, and reciprocating engines including those built by the Tognum joint venture with Daimler AG. Maintaining a strong credit rating is a priority, he said.

Rolls-Royce remains under investigation by the U.K. Serious Fraud Office over potential wrongdoing in business dealings in Asia. Fraud prosecutors, aided by the U.K. National Crime Agency and the City of London Police, said yesterday they arrested two people and searched properties in the probe.

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