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Rolls-Royce and Other AGMs
Yesterday I attended the Annual General Meeting of Rolls-Royce Plc – held at 11.00 in Nottingham (at a conference centre on the University Park). Why move the venue from London where it has been held since 2004? Probably to attract a more sympathetic audience of ex-employees I suspect.
Shareholders in Rolls-Royce don't need to be told that this company is going through a rough patch. Profits in the last two years have been miniscule, the dividends have been cut and even revenue has been falling. The CEO was changed last year, which no doubt was one result of this.
On the morning of the AGM the company issued a statement which was not particularly upbeat. Although it said that trading in the first few months of the year was in line with expectations and the outlook for the year as a whole was unchanged, it also said that the first six months was only likely to be breakeven in terms of profits and that profits will be weighted towards the second half. This kind of statement is usually read by investors to really be saying "the first half was bad but we hope to do better in the second half" but from experience we know that this can be a case of "hope springs eternal". The share price promptly fell by over 5% but it did recover somewhat later in the day.
What follows is a summary of what was said at the meeting and the Q&A session.
The Chairman, Ian Davis, opened by saying he recognised the past year has not been comfortable for shareholders. The performance was also not acceptable to the board. Substantial changes are in hand. The board's decision to halve its payments to shareholders was not taken lightly. But it enables the company to continue to invest in the business. Shareholders have expressed their impatience however.
He went on to explain the changes to the board – new CEO Warren East, new non-exec director Bradley Singer (nominated by ValueAct Capital who have taken a big stake), and other changes to the non-executives. (Comment: I raised the issue last year of the number of directors and their backgrounds – there are still 15 directors, some of which seem pretty irrelevant so not much has changed in that respect).
The Chairman said Warren East has made a very strong start and he has devoted formidable energy to implement change. But there were significant short term headwinds – low commodity prices, the cost base is too high, etc. However the order book continues to grow. The key to success is to develop world-class technologies. (Comment: no the key in technology businesses is not just to develop the technology but to learn how to market and sell them profitably on which Rolls-Royce clearly has lost the plot).
We then received a video presentation on Rolls-Royce activities (fairly bland), and then Warren East gave a presentation. Mr East is a somewhat unimpressive person physically but spoke reasonably well although I was not really that much clearer on the future prospects for the business afterwards. He said that last year was difficult with hostile newspaper headlines and some long-term supporters decided to take a break (comment I presume he meant some shareholders chose to sell). But he said it was a fundamentally strong business with outstanding growth prospects.
He then summarised the financial trends. Underlying revenue was down 1% but high fixed costs meant profits were down 12% and cash flow was substantially reduced. There was a big drop-off in the Marine division due to exposure to the oil/gas sector and the transition of Trent aero-engine models had a large impact.
His review of the business after he took over enabled him to identify improvements. But they also need to improve communications with shareholders. Over many years they have built complexity into the business and that "slows us down". He is looking to change behaviour in this area. So the three key words are "transform, focus, deliver" (as on the cover of the Annual Report incidentally).
He asked "what makes Rolls-Royce different". The answers given were engineering excellence (e.g. the XWB engine – the most efficient engine of its size). He also said great engineering is a necessity but it is not sufficient. They need to focus on operational excellence. Therefore they are reducing management and making other cost savings. The company is in a period of huge changes, but he has great confidence in the future.
We then moved onto questions from shareholders.
I said last year I wrote in a note to ShareSoc members that Rolls-Royce seemed to have a problem of turning orders into deliveries. Orders continue to grow but revenue does not. Last year proved to be the same. Could Mr East please explain why deliveries seemed to be problematic. He outlined how they would improve later this year and next. I also suggested they need to publish a different "orders" figure because it was clear orders can be deferred by customers.
I also asked bearing in mind that we are doing a paper poll, so the results would not be available until the next day, did any significant votes against resolutions get cast on the proxy counts? The Chairman said the votes were overwhelmingly in favour of all resolutions. I was not satisfied with that answer and asked, does that mean less than 3 per cent against? He said Bradley Singer got more than that against. Comment: this is not surprising because some institutions considered him "not independent" but the Chairman certainly tried to avoid giving a straight answer to my question – and see below also!
Another question from me: I welcomed the fact that pay had fallen because the incentive scheme targets were not met. But the company had now introduced two new "soft targets" which were employee and customer engagement. Could an explanation be provided? The answer given was that there were specific measurement targets for these and they were important elements. I asked why they had not published the targets. Answer given was that this is not normal practice but they would be published in 2017. (Comment: this is a typical example of targets not being achieved so the scheme is then changed to introduce new and easier targets. I also do not accept that the targets should not be published up front, otherwise they can be changed later without shareholders knowing).
In general this was an unsatisfactory meeting in some ways. Really did not get a great deal more understanding of the problems regarding lack of profitability (new engine deliveries might increase but I do not expect that to have an instant impact on profitability – it might actually consume more cash from additional work in progress in the short term). Unfortunately the Chairman seemed to think this meeting was more about a public relations exercise for small shareholders than answering real business questions with plain answers.
In particular I learned the next day that the Chairman had failed to point out in response to my question on proxy votes that not only did Brad Singer only get 94% of votes FOR, but resolution 21 on allotment of shares only got 86% of shareholders voting FOR. I would not be surprised if ValueAct voted against that to avoid dilution of their stake.
This shows why voting on a poll is not a good idea because it avoids shareholders seeing what the votes are and asking questions about them on the day. I have written to the Chairman pointing out this and one or two other problems with this meeting and enclosed a copy of the ShareSoc guide to how to run a General Meeting (available from our web site).
I can't say I am very happy with the Chairman of this company in general. He seems to have lots of other jobs and no particularly relevant experience regarding running engineering companies. In addition the problems at Rolls-Royce have arisen on his watch so I think a change of both CEO and Chairman would have been appropriate. Plus he does not seem to like challenging questions from shareholders. A change here would also surely be timely!
A number of other reports on AGMs have been posted lately as this is the AGM season. That includes: Rightmove (RMV), Rolls-Royce (RR.), Amerisur Resources (AMER), Pearson (PSON), Spirent Communications (SPT), Segro (SGRO) and McColls Retail Group (MCLS).
ShareSoc Members not only gain access to these reports but can of course also contribute their own. You can see from the above report that attending AGMs can be very revealing – for example it made it very plain that the recovery of Rolls-Royce is going to take some time.
Roger Lawson
Post Date: May 6, 2016