Share tip of the week: old hand to ride out recession

By Paul Hill Mar 27, 2009

Paul Hill

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Rolls-Royce, the British turbine maker, is the quintessential long-term investment story. Founded in 1904, it has endured two world wars and numerous recessions. This business has more than enough staying power to survive the current crisis. In fact, it's probably in better shape now than ever before. At the end of December it had an order book worth £55.5bn (equivalent to 5.7 years' sales) and a balance sheet with average net cash of £375m. And Rolls-Royce is no one-trick pony any more. It's a well-balanced engineering giant with operations in aerospace, as well as marine, energy and defence sectors. Along with the huge backlog, 52% of turnover is derived from its rich seam of repair and maintenance contracts servicing its customer base.

Rolls-Royce (LSE:RR), rated a BUY by Cantor Fitzgerald

This year will be much tougher than last, especially in the firm's largest unit, the civil aerospace division. Demand for narrow-body and corporate jets had softened, while the Airbus A380 super-jumbo and Boeing 787 Dreamliner programmes have led to delivery delays for a number of its Trent engines. But this should be offset by better profits in its other units. Chief executive Sir John Rose expects 2009 revenues to keep growing with "underlying profits remaining broadly flat". The City expects 2009 turnover and underlying earnings per share (EPS) of £9.5bn and 34.4p respectively, putting the stock on a p/e ratio of only 8.7. It also pays a reasonably secure 4.7% dividend yield.

Further out, prospects look even better, despite the tough environment. As Rolls-Royce generates 84% of its sales from overseas, sterling's weakness will increasingly make it a low-cost producer, especially compared to foreign rivals such as GE Aerospace and Snecma.

So what are the risks? The aftermarket side would be hit if a big chunk of the global air fleet is mothballed due to a prolonged downturn in the travel industry. Rolls-Royce would also suffer if a large customer went bust – engine orders could be cancelled and the firm might also be forced to unwind some of its hedged foreign-exchange contracts – potentially leading to a big cash outlay. But I'm confident that the finance director is already well on top of this counter-party risk and has probably bought some sort of insurance in the case of default. All told, while Rolls-Royce won't make you a millionaire overnight, I'm confident it won't disappoint over the economic cycle.

Recommendation: long-term BUY at £3.02

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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