Rolls-Royce price target slashed to 640p by JP Morgan

7th Jul 2015 09:39

JP Morgan Cazenove downgraded Rolls-Royce and slashed its target price after the engine maker's profit warning on Monday, foreseeing three or four years of uninspiring sales and low returns.The UK broking arm of the US bank cut its rating to 'underweight' from 'netural' and reduced its price target to 640p from the previous 900p on what it said was the most expensive stock in the aerospace and defence space "by some measure"."Over the next three to four years RR will be in a major transition phase, with falling sales of mature high margin aero engines and rising sales of new, loss-making engines. This suggests three to four years of average sales growth and low RoCE [return on capital employed]."The FTSE 100 company's fifth profit warning since Jan 2014 revealed a much greater drop in operating profits on the Trent 700 engine on the Airbus A330 than expcted, weaker business jets deliveries and regional jet aftermarket sales, as well as weaker sales into the oil & gas market.As a result, JP Morgan has cut its 2015 expected earnings per share (EPS) by 7% and its expectations for 2016-18 EPS by circa 30% per year.After new chief executive Warren East talked to analaysts, JPM said it now appeared that the review leading to this profit warning was largely the work of the CFO, with a deeper review planned by East that could presage further changes to guidance.Despite the big profit warning, shares in RR fell only around 6% on Monday, which led to the bank's analysts feeling "somewhat nervous" that they had missed something.They suggested there were several possible reasons for this: that the shares were already very weak into the profit warning, that many investors are still buying into the longer-term investment story, that investors believed East could take some radical decisions, or that the market sees this warning as a "guidance reset", allowing for potential upgrades in the future.With the removal of the share buyback support, JP Morgan said it believed investors wanting to buy into the long-term story "can afford to wait for a better entry point".