Outlook for UK aerospace sector remains strong despite Rolls-Royce write-down

The outlook for the UK aerospace industry remains strong despite Rolls-Royce reporting a pretax loss of £2.15bn in its half-year results, says Michael Minall, director and aerospace sector specialist at supply chain firm, Vendigital.

The statement from the company on July 28, 2016, puts the main reason for its pretax loss down to hedge book valuation adjustments in the wake of Britain’s vote to leave the European Union and falls in the value of sterling. In accounting terms, such adjustments, often described as ‘write-downs’, allow businesses which are trading internationally to minimise the impact of currency fluctuations on their business performance.

The British engine manufacturer primarily trades in dollars but books revenues in sterling. For this reason, major changes in currency valuations can have a dramatic effect on profit performance. However, as a non-cash item, this adjustment does not reflect the company’s underlying trading performance. In this case, the size of the write-down is due to bad timing.

When preparing half-year reports, the business must apply currency valuations as they were on the final day of the trading period – which in this case was the 30^th June 2016, just one week after the Brexit vote and the value of sterling had fallen significantly. If the referendum had taken place a week or so later, the company’s half-year reports might have looked entirely different.

While these half-year results are an accurate reflection of the shock caused by the Brexit vote, they are just an economic snap shot of how things were at that time and the longer term outlook for the sector is much better than these figures suggest.”

Over the last six years, order intakes in the sector have climbed significantly and UK-based businesses, such as Rolls-Royce and their suppliers have strengthened their position in the global industry; securing international orders and making significant efficiency and productivity gains. The volume and long-term nature of these contracts mean that businesses in the sector are expecting to be operating at an unprecedented capacity well into the future.

Despite the uncertainty caused by the Brexit vote, order books have never been stronger and global demand for air travel has driven significant requirement for new aircraft and engines. In this sense, businesses in the sector just have to get on with doing what they do best, which is manufacturing world class products efficiently.

Brexit scenarios

Despite their strong order books however, aerospace and defence businesses also need to plan ahead for a variety of Brexit scenarios. For example, if they are buying raw materials or components from Europe, they may need to consider the impact that new tariffs could have on these trading relationships. They also need to consider access to skilled labour and put plans in place to secure this.

The UK aerospace industry currently employs around 16,000 EU nationals, many of whom are in highly-skilled positions attracting average salaries in excess of £40,000 per annum. As things stand, it is unclear where these workers will come from in the future or whether UK businesses will be able to continue to employ them once Brexit terms are agreed. To guard against a skills shortage and the impact this could have on productivity, businesses in the sector need to start planning now. Ideally, businesses should appoint a Board-level Brexit representative to help manage change and drive efficiency.

Businesses may also need to change their approach to supply chain management. Reviewing existing and pending long term contracts will be essential, not only in understanding exposures but also in understanding what commitment you may or may not be able to fulfil, for example, who will be responsible for duty payments and could Brexit be considered as force majeure. Other may decide that adopting a more multinational supply chain will reduce risk in their cost base.

Another important area to consider as Brexit arrangements take shape is that of regulatory approval. At the moment, all products used in civil aircraft in Europe require regulatory approval from the European Aviation Safety Agency (EASA). As Brexit negotiations get underway, it will be important for UK industry to have a voice in determining what happens in the future.

As yet there are many uncertainties but there is no excuse for aerospace businesses based in the UK to have their head in the sand. Unlike businesses in many other sectors, aerospace firms have the advantage of robust order books and customer demands that need to be met.

Staying focused on efficiency and planning for all eventualities in terms of any impact that the Brexit might have on access to skills, tariffs and certification will be critical in the months and years ahead and businesses should also look out for opportunities that might arise from new trade deals with the rest of the world.

Michael Minall is director and aerospace sector specialist at supply chain firm, Vendigital