British Airways and Rolls Royce

Very few industries, if any at all have not been affected by the attacks. Rolls Royce is no exception. As the world waited with held breath for the markets to open in New York, many institutions around the world could do nothing but wait. No one could know what was going to happen although many could predict that fear would spawn massive liquidation. One thing for sure, areas to avoid included the airline stocks and insurance industries.

September 14, UK stocks began to fall, the plummet lead by British Airways and Rolls Royce. The FTSE 100 Index fell 5 percent or 22 points, British Airways by 17.75p and Rolls Royce by 7.5p to 174.25. With fear and concern that the US would enter into war with oil producing countries oil prices rose, both BP and Shell climbing 2.2 and 3.5 percent respectively. By September 17, UK stocks had experienced their steepest decline in 14 years with the FTSE 100 falling a total of 28 points, and a slide in Rolls Royce of 18.5p to 147.

By Oct. 14 Rolls would pronounce that it would have to cut another 3,500 employees due to the slowdown of sales as a result of the attacks. Shares fell further to 133p. Boeing also announced it would let go of 12,000 of its employees by the end of the year, Merry Christmas. Losses for Rolls will come as older planes are grounded and taken out of service. It is in the after sale overhauls and maintenance services that the company makes its greatest profits. The initial sale yields a small return, but as planes get older they require more maintenance and this is were Rolls makes its money.

As markets began to recover slowly, Rolls also began to make a strong recovery, all things considering. However, when it seemed like the situation couldn’t get any worse, reports that another American Airlines plane had crashed on Nov. 12, US and UK markets falling again. The benchmark FTSE 100 fell 84.9 points, British Airways plunged, and Rolls Royce slid back down to 160. Rolls Royce shares fell a total of 40 percent between the Sep.11 attacks and Oct.2. The airline industry continues to suffer from little demand in air travel. Airlines have begun to retire old planes depriving Rolls of earning sales on maintenance. The market share value has regained about 20 percent of its pre Sep.11 value, and is currently trading at 177.26 (December 8, 2001).

As global competitor, Rolls Royce is exposed to certain financial risks associated with movements in different global markets. It uses various financial instruments to protect itself from these exposures that may arise. The risks most apparent with movements in financial markets are those in foreign currencies, interest rates, and commodity prices. The company does not trade instruments for profit, only for managing risk. To hedge these risks the company uses a number of derivatives including jet fuel swaps, interest rate swaps, currency options, and forwards foreign currency options.

Movements in exchange rates of foreign currencies effect both foreign transactions and the conversion of profit and loss accounts. The most significant exposure is that of the US dollar to Sterling. US income accounts for 42 percent of its UK turnover. The company covers its exposure through the continual hedging of standard foreign exchange contracts and currency options against their dollar income. In fact, risk managers tend to use covered option writing as a means of protection.

“We do believe that buying and writing of options can complement our hedging policy… We will in no event ever write options if there is no requirement to have the underlying there in the first place… that is we will not write naked options.”(Mark Morris, financial risk manager, “No Fear of Options Here,” Corporate Finance, July 1994, p. 44) A point of interest lies where Rolls Royce sells sterling puts on the dollars its receives as income. To sell a put when it already has a forward position seems to be somewhat equal to a call option.

The company manages its interest rate risk by using interest rate swaps to change fixed rate borrowings into floating rate borrowings in order to match the rates of short-term bank deposits. Commodity risk includes the company’s sensitivity to changes in the price of jet fuel. In order to best hedge against changes in the price of jet fuel it has entered into jet fuel swaps.  The following report was written with the intent of displaying the financial position of United Kingdom Rolls Royce Plc.

An analysis is given using company reported data spanning from January 1996 to December 31, 2000, and statistical data up to the week of December 4, 2001. Market values are based on share price taken November .. The report uses information and has derived calculations from the annual report of 2000. These calculations include that of the dividend policy and growth rate, cost of capital, both equity and debt, and their weighted averages. These calculations, although limited in depth, are fundamental in analysing the company’s current financial capital structure.

Bibliography

1. Rolls Royce plc. Annual Report 2000, www.rollsroyce.com.

2. Bloomberg Professional, RR / Equity Headline News.

3. “No Fear of Options Here”, Corporate Finance, July 1994.

4. Lumby ; Jones, Investment Appraisal ; Financial Decisions. Third Edition, 1999.

5. “News Scan P.M.: Oct. 25, 2001”, forbes.com staff, www.forbes.com.