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Rolls-Royce begins new chapter

Investors react positively to Warren East's appointment, but it could be a while before the new boss can work his magic
April 27, 2015

John Rishton's decision to call time on his troubled stint as chief executive of Rolls-Royce (RR.) "to have a little rest" wasn't exactly met with tears by markets. While just days earlier the announcement of a $9.2bn (£6.1bn) order for 200 engines to power Airbus A380 superjumbos - one of Rolls' biggest deals in history - barely triggered a reaction from investors, Mr Rishton's sudden departure sent the shares climbing 4 per cent.

IC TIP: Hold at 1043p

Such a bullish response to the current 1,033p may be attributed to the reputation of his successor Warren East, who is widely credited for transforming microchip designer Arm (ARM) from an upstart into a global leader in chip designs for smartphones. Under his stewardship from 2001 to 2013, Arm became one of the world's leading semi-conductor companies, developing chips for the Apple iPhone.

An impressive CV led some commentators to herald him as the ideal candidate to revitalise Rolls-Royce's technical prowess. That includes Lewis Sturdy, a dealer at London Capital Group, who described the appointment as a "shot in the arm for Britain's biggest engineer" that will add "£350m in value".

Such discontent for Mr Rishton's tenure will not have been helped by what turned out to be a nightmarish 2014. A series of profit warnings and investigations into alleged bribery sent Rolls' shares plummeting by over a third last year, as investors began to express apprehension over the company's strategic direction.

Of particular concern was Mr Rishton's decision to expand Rolls-Royce's marine and power systems business. With the backing of chairman Ian Davis, the chief executive sought to diversify away from the cyclical nature of the aerospace division, which accounts for up to 50 per cent of turnover and a greater share of group profit.

The decision, however, to spend €2.4bn (£1.7bn) buying Daimler out of a diesel engine joint venture to bolster its marine operations has since backfired, as oil prices hit rock-bottom. Mr Rishton was also known for his efforts to cut costs - there were 2,600 job losses in November - and his controversial decision in 2011 to exit the narrow body aircraft engine market - it has since become the fastest growing sector of the industry.

But despite ending his tenure slap bang in the middle of arguably one of Rolls-Royce's most tumultuous periods in its 109-year history, Mr Rishton may one day be remembered more affectionately for improving the punctuality of engine orders and leaving behind a record order book of £73.7bn. Increasing profits by 69 per cent and sales by just over a third since taking on one of the trickiest jobs in British industry four years ago, too, shouldn't be forgotten.

Those hoping for a drastic change in strategy under Mr East's leadership may be in for disappointment as well. Chairman Mr Davis has already confirmed that there will be no immediate change to the group's strategy, thereby pouring cold water over a wishlist that includes a return to narrow-body engine markets and a swift exit from marine operations.

Given the complexity and politics of the business and the fact that low oil prices are likely to deal another blow to Rolls-Royce's performance in the year ahead, Mr East will have to be patient. Instead of vast changes and immediate growth, further profit warnings could well crop up in the coming months, and are likely to be met with further backlash from increasingly disgruntled investors.

Some analysts have even speculated that such disappointments could spur the way for a richer US rival to make a bid. With the dollar up 12 per cent against sterling over the past year, recent currency movements make it cheaper for US behemoths to snap up underperforming European companies. But should an offer be forthcoming, Rolls-Royce's status as a celebrated British company would likely trigger a messy storm of public debate.