PROPOSAL TO THE BOARD OF DIRECTORS
Both Rolls-Royce and Smiths are top performers in their markets with high potential for sales expansion, strong profitability and long-term presence. They have resisted well the economy downturn in 2002-2003 and are now successfully further growing their installed basis, improve profitability and cash generation. Forecasts for both are promising. They are currently rated equally A3 stable by Moody’s.
We have conducted our analysis of the two companies on an as common as possible basis in an attempt to ease comparability and eliminate the risk of influence from distorted data. The analysis showed that:
- Smiths enjoys stronger profitability margins, lower indebtedness and better asset turnover. It pays to its shareholders on average three times higher dividends and its forecasted profitability is 3 basis points above Rolls-Royce. Its cash flow generation is strong and is expected to further increase. EPS is expected to double by 2008 while Rolls-Royce’s EPS forecast is set for a 60% increase.
- Rolls-Royce is double the size of Smiths in terms of turnover and three times bigger in terms of total assets although its equity base is only 25% larger. It presents very high liquidity and excellent cash generation capacity. It is less working capital intensive and has a shorter cash conversion cycle. Its gross margin is currently 10% lower than Smiths but it is constantly improving in contrast with Smith’s gross margin trend. Rolls-Royce is more geared but its operating profit is higher and covers interest comfortably. Definitely Rolls-Royce is a cash king with positive and growing net cash position in the past years, projected to slightly over £1bn net cash at end-2008.
We believe that each company constitutes an excellent choice depending on the Fund’s strategic requirements:
• Smiths is a better choice for a strategy based on increased income levels.
• Rolls-Royce is a winner should the Fund opt for capital...