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Rolls Royce’s Value Sensitive Decision On Narrow-Body Market

|Includes: Rolls-Royce Holdings plc (RYCEF)

Using a surfing term, the aero-engine maker has found its self out of position to the big shift in the market, which is mostly of its making. Former chief executive, Sir John Rose, sold out of a joint venture with Pratt & Whitney for narrow-body aircrafts at the time when the big demand wave for narrow-body planes was just beginning. Depending on whose view of the future you use, Boeing or Airbus expect new narrow-body deliveries to be between 22,900 and 26,730 over the next two decades, of which GE Aviation and Pratt & Whitney have already secured a strong beachhead and COMAC has made no secret of the fact that Chinese plans to enter. Yet the new CEO, Warren East, told investors, late last year, that "as there isn't an opportunity for us to re-enter this business until 2030s, this is actually not something that we should be wasting our time on right now in terms of debating."

As the window of opportunity for the strategic decision to enter the narrow-body market is closing and the timing of this decision is so critical to the company's future, we are of the opinion that the analyst community should be sharing their thoughts on the mater. We believe that the company is faced with four possible options:

1. To continue its focus on wide-body market. The company's profits will be tied to the large waves within the wide-body market. It will need to counter this with a diversified program;

2. To renter the business by merging with Pratt or with others such as MTU Aero-engines to form an European wide consortium. The company would not be a stand-alone entity and also there is the government's shareholder executive to placate;

3. To renter the narrow-body business as stand alone competitor. Shareholders may be concerned about the demand for cash required and risk/return profile;

4. To renter the business through a joint venture with a new competitor such as the Chinese. This decision may impact existing relationships with other engine makers, although the rewards are great. Also, the new entrant could turn its sights on the wide-body market further in the future.

Assuming the typical development time for a new engine is between 7 to 10 years, the first two demands no action at present and can be left until closer to year 2030. But both the third option, which requires building a war chest before hand, and the last option, which demands building right relationships with joint venture partners at first, require action right now. Therefore, parking the decision until closer to 2030 implies the elimination of the last two options. We believe that this is one of the key reasons for why talk of a merger with Pratt &Whitney thrives. What are your thoughts on whether all options are still on the table?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.