Selvan Masil's Sohn London Presentation: Long Rolls Royce, Short Ericsson ~ market folly

Monday, December 7, 2015

Selvan Masil's Sohn London Presentation: Long Rolls Royce, Short Ericsson

We're posting up notes from the Sohn London Investment Conference 2015.  Next up is Selvan Masil of Westray Capital who pitched a long of Rolls Royce (RR.L) and a short of Ericsson (STO:ERIC-A, ERIC-B).

Selvan Masil's Sohn London Presentation 2015

Selvan Masil founded long/ short equity fund Westray Capital Management in April 2014. Before that he worked at Theorema Advisors, Pelham Capital, and Lansdowne Partners.

Long Rolls Royce (LON: RR) Rolls Royce primarily makes and services jet engines for aircraft. Aero engines are a good business:

- Air passengers double every 15 years

- The order backlog for wide bodied planes is at historic highs

- Fuel is the largest cost for airlines – around 60%. New engines that provide fuel savings are crucial to the future of airlines.

- The barriers to entry are high due to safety concerns and because engine development for wide bodied planes takes time to pay off. New engines lose money for the first 10-15 years before breaking even.

- There are few competitors : GE, Safran, Pratt and Whitney.  Masil sees no sign of a new entrant for the next 10 to 15 years.

- Rolls Royce has issued 5 profit warnings in a row in the last two years. The previous management did not communicate well with investors. Masil thinks that Rolls Royce is at an inflection point.

- Rolls Royce is at the start of capturing new market share. The order book suggests that it will double its market share in wide bodied engines in the next 15 years.

- Profitability will trough in 2016 and then pick up. Masil thinks that margins will pick up sharply by 2019. Consensus estimates for 2019 only show margins making a small improvement from today. 

- RR’s profit margins are not as good as Safran or GE’s which are around the 20% mark. RR can potentially close this gap over time.

- The new CEO, Warren East, is addressing some of the problems with a package of self-help measures – cost cutting, management redundancies and better communication with investors.

Short Ericsson (STO: ERIC-A; ERIC-B) Ericsson is a network equipment company. The industry dynamics are poor. There is pricing pressure in an increasingly commoditised industry due to competition from Asian manufacturers. The recent merger of Alcatel and Lucent has also created a stronger competitor. EBIT margin will be under pressure for a number of years. Ericsson has not done well in taking market share of the 4G market.  Ericsson’s P+L statement overstates profitability – the restructuring charges are not one off/ exceptional but rather ongoing.

Be sure to check out the rest of the Sohn London Conference presentations.

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