Analysis: Rolls engine scare highlights wider aerospace risks

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Even if the fiery blowout of a Rolls-Royce engine (pictured) proves no fault of the builder, recent setbacks in aerospace could force investors to rethink bets on the next generation of far more challenging planes.

“This incident serves as a wake-up call,” said Nomura aerospace analyst Jason Adams. “Investors are right to ask the question ‘Are there going to be more problems down the road?’.” The world’s biggest passenger plane is already slipping into the shadows as Airbus and Boeing press on with their next designs, which will push the limits of carbonfibre and other technologies.

As they do, the stakes rise for the likes of Rolls, which aims to build far more engines for those planes than it has for the slow-selling A380. “There are a lot of execution risks with companies like Rolls,” said Nomura’s Adams. Such risks were highlighted earlier with production of the A380, when fiddly sets of wires proved too short to join up properly, forcing costly rewiring.

With the Qantas incident pointing to a possible oil leak, investors are again reminded that even minor setbacks can rock shares and dent reputations. Rolls shares lost 10 percent after the blowout and slipped further after Singapore Airlines said it would replace engines on its A380s and European inspectors ordered tests on the engines. Analysts said the damage would have been far worse had Rolls not quickly ruled out any link between the Qantas incident and an explosion in August while testing a new Trent 1000 engine destined for Boeing’s next new plane, the 787 Dreamliner.

Rolls expects to make most of its profits in coming years on the Trent 1000 and Trent XWB for the Airbus A350. Still, the two engine setbacks for Rolls have underscored the huge changes taking place in the aerospace industry, which promise to eclipse the A380 in technology and market share.

Rolls is more exposed to the next generation of new mid-sized Airbus and Boeing planes, which come with new engines, than arch rival General Electric.
“With each new commercial aircraft, the complexity is increasing exponentially and adding to the risks of the manufacturers involved,” said Nomura’s Adams. “Investors in companies that carry significant development risk need to be compensated for that with upside potential.”

Such risks were highlighted again this week when Boeing halted flight tests on the 787, already three years late, after cabin smoke forced an emergency landing of one of its test planes. Rolls shares were at a record high on the eve of the Qantas blowout, suggesting investors took a sanguine view of the risks inherent in those programs. They have risen a quarter this year, outperforming London’s FTSE All Share Index .FTAS and the sector by 14 and 16 percent, respectively.

They trade at almost 15 times 2010 earnings, while the FTSE All Share Aerospace and Defense Index trades at 10.57 times. In the 100 years of its history, aviation has undergone two major generational changes; from biplanes to monoplanes and then from propeller to jet engines. A third is under way as jetliners move from metal to carbon composite, or strong plastic.

Not only is Rolls more exposed to the new planes than rival GE, it has less to fall back on if they prove problematic, having so far held back on planning a new powerplant for smaller narrowbody jets, which make up most of the market by volume.

Virginia-based consultancy Teal Group estimates the market will reach 24,000 turbofan engines worth $250 billion over the next 10 years. Rolls competes with GE for engines on the Boeing 787 but is the only supplier on Airbus’s future competitor, the A350. GE remains ahead in sales for bigger planes and far ahead for those that power smaller ones. On the latter, GE sales could reach $47 billion versus just $6 billion for Rolls, said Teal Group President William Storey.



Yet Rolls knows better than most the risks and rewards in jet development. Its RB211, father of the Trent, drove it into bankruptcy and nationalization in 1971 before the company rebounded. “I’m interested to see if there’s a material technology issue on the Trent 900, but I wonder if this shows that engine technology has been taken as far as it can go,” said Howard Wheeldon, senior strategist at brokerage BGC Partners. “You need two suppliers in this market; heaven forbid if there was just one supplier out there, because the price of engines would go rocketing up.”