Vince Julier - June 18, 2018
On June 14 Rolls-Royce Holdings PLC announced that it is cutting 4,600 jobs to deliver some £400 million in annual cost savings by the end of 2020. At the same time, they are targeting £1 billion of free cash flow by 2020. FREĠNAN examines what the numbers currently say about Rolls-Royce and how these targets may affect the future shape of the company.
First the current numbers.
FREĠNAN uses artificial intelligence and web harvesting to create data driven, unbiased, high quality predictive company models. FREĠNAN used its advanced analytics platform to create a wholistic and predictive financial model of Rolls-Royce PLC.
FREĠNAN’s engine found that the relationship between a £1 increase in revenue resulted in a £0.96 increase in total operating cost. This £1 increase in revenue also translated into a £0.18 increase in net income, but only a £0.03 increase in free cash flow.
The engine also generates FREĠNAN's unique and proprietary model accuracy indicator, the company model’s ‘predictivity score’. Rolls-Royce’s predictivity score is high at 5.4, putting it in the top decile of the FTSE100, which gives some comfort to the accuracy of these findings.
Given Rolls-Royce’s desire to generate £1 billion per annum of free cash flow by 2020 it is clear that this historical relationship needs to change.
And now the future scenario.
Part of FREĠNAN’s capability is the ability to combine its machine learnt predictive model with manual interventions, so that scenarios and management targets can be explored.
To that end FREĠNAN combined Rolls-Royce’s predictive model with a £400 million reduction in cost of revenue. At today’s revenue, the £400 million cost of revenue reduction will improve Rolls-Royce’s free cash flow to around £370 million, but still make it short of the £1 billion target. To achieve £1 billion of free cash flow, revenue would also have to grow to at least £18.5 billion from its £16.3 billion today. The question then rests on whether this can be achieved.
So what about share price.
One of FREĠNAN’s advanced machine learnt capabilities is to create an implied share price based on how a company’s historical performance has been translated into market value. This is not a share price target or an estimate of ‘value’, but an unbiased calculation of how the market has historically imparted value given a company’s financial performance
For Rolls-Royce, given its performance reported in its 2017 accounts, FREĠNAN’s engine carries an implied price of 909 pence per share, 62 pence higher than the price at the time of the 2017 accounts. Today (at the time of writing this blog – June 18th) Rolls-Royce Holdings PLC’s share price has climbed to 922 pence per share – a premium with respect to its historically implied price.
So what, given the scenario above (a £400 million reduction in cost, an increase in revenue to £18.5 billion, a free cash flow of £1 billion), would FREĠNAN’s implied share price be? The answer the model gave is 942 pence per share, within today’s trading range.
Please remember that FREĠNAN does not provide or offer any financial or investment advice on any shares or other investments and does not provide you with any recommendation on investments you may choose to make.
We just show you want the numbers say.