Shares in engineer Rolls-Royce Holdings (LSE: RR) fell by nearly 6% this morning after the group’s new chief executive, Warren East, said that 2016 would be “a challenging year”.
Mr East’s comments were made in the firm’s AGM statement. Reading this has left me uncertain about the outlook for the firm. Although Rolls said that trading so far this year has been in line with expectations, the group warns that profits will be “significantly weighted towards the second half” of the year. Relying too heavily on a better second half is often risky, as hoped-for improvements don’t always arrive.
Looking on the bright side, Rolls also said today that if exchange rates remain stable for the remainder of the year, pre-tax profits may be £50m higher than expected. The firm also says that it’s on track to deliver cost savings of £30m-£50m this year.
My view is that the market reaction is probably correct. It’s too early to deliver a verdict on Rolls’ turnaround, but on a 2016 forecast P/E of 25, the shares aren’t obviously cheap. They could fall further.
A limping performance
Rolls’ marine division has been hit hard by the downturn in the energy market. A more surprising casualty of the oil crash is medical technology firm Smith & Nephew (LSE: SN), which makes replacement joints.
Smith & Nephew said this morning that sales in emerging markets fell by 6% during the first quarter as a result of a significant slowdown in China and “in oil-dependent Gulf states”. The firm’s shares were down slightly in early trading, but the news wasn’t all bad.
The company reported a 6% rise in sales in established markets, with the US up 8%. Underlying group revenue rose by 4% to $1,137m compared to the same period last year. Despite this, I’m not sure now is the best time to buy. Smith & Nephew shares currently trade on 19 times 2016 forecast earnings, but broker forecasts for 2016 have been cut by nearly 10% over the last 12 months.
I’m also concerned about falling profit margins, as the group’s operating margin has fallen from 20.4% in 2012 to just 13.6% in 2015. I believe there’s better value elsewhere in the pharma sector.
Oil troubles have hit this firm too
The wider impact of the oil slump is becoming more and more visible. Rupert Pearce, chief executive of satellite internet provider Inmarsat (LSE: ISAT), said this morning that the firm is seeing a “sustained recession in global maritime and energy markets”.
A reduction in offshore oil activity and high levels of ship scrappage are reducing demand for the firm’s internet services. As a result of this downturn, Inmarsat has cut its revenue guidance for 2016 by $50m to a range of $1,175m-$1,250m.
Given that revenue only fell by $6.2m during the first quarter, the scale of this reduction suggests to me that conditions may continue to worsen as the year progresses.
Inmarsat’s share price is down by 5% so far today, and has fallen by 22% so far in 2016. Despite this, the firm’s shares still trade on a 2016 forecast P/E of about 28. In my view, the worsening outlook makes this too expensive.
