Rolls-Royce's Tognum adventure

Holding shares in Rolls-Royce this year has been a far smoother ride than might have been anticipated when one of the company's Trent 900 engines powering a Qantas airliner exploded on a flight to Australia late last year. The measured calm with which chief executive Sir John Rose handled what could have been a terminal situation exemplified Rolls-Royce's incremental approach to business. Sir John left the group this week after 15 years as the boss. However, as a signing-off present, he left shareholders with a proposed deal to take a half-share in a €3.2bn (£2.8bn) joint venture to buy a German engines maker. In so doing, he also leaves Rolls with a bright future.

The Qantas episode, if anything, enhanced the group's reputation for quality engineering. The fact that the engine problem turned out to be down to easily-replaced rubber components has given airlines the confidence to start ordering Trent 900 engines again. The latest order was to equip six Airbus super-jumbos recently bought by South Korean airline Asiana, and it reflects the simple fact that the group's engines have a technological edge over those offered by rivals.

But the most interesting new development is the proposed takeover of German engines maker Tognum in a 50:50 joint venture with German engineering giant Daimler. The deal would result in Rolls managing Tognum, into which it will slot its diesel marine engines maker, Bergen. The deal is unusual in that management does not expect to find many cost savings, so there won't be easy pickings to boost profits. However, analysts at broker Evolution reckon there might be an annual boost of 10 per cent to earnings as Tognum is profitable. Buying Tognum also looks like good use of the group's cash. Currently, it has £2.9bn of gross cash earning only nominal returns. Rolls will exchange a good chunk of that for a business that, City analysts reckon, will immediately produce a 5.7 per cent cash return.

But Rolls is more about actual engineering than the financial variety. What interests Rolls about Tognum is its niches in marine engines and energy generation, as well as high-performance diesel engines for agricultural and specialist vehicles. Rolls is well represented in marine engine technology, but Tognum has a market share of 30 per cent for some types of specialised sea-going propulsion units, particularly for smaller craft such as patrol boats. Clearly, the access to new markets via Tognum is tempting.

For example, Tognum's power division had sales of €742m (£656m) last year, and operating profits of €32.8m. That came from high-margin sales of original equipment, particularly to the booming Chinese nuclear energy industry. It compares favourably with the respectable, if unspectacular, performance of Rolls's energy generation division, where operating profits of £27m in 2010 were generated on sales of £1.2bn. So, clearly the addition of Tognum should boost this division and would fit in nicely with management's long-term aim to reduce the group's reliance on selling engines to civil aircraft makers. Tognum also has a joint venture with a Chinese company, which gives Rolls a foothold and a manufacturing base in that country. There is no question, either, that Rolls will strain itself with the Tognum deal, which has yet to be approved by shareholders. Rolls will still have around £400m of liquidity left on its balance sheet.