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Rolls-Royce set to report biggest ever headline loss

Rolls-Royce is set to report the biggest headline loss in its history next week, as it absorbs the impact of its £671m settlement with regulators for past bribery and corruption as well as a weaker pound.

The UK aero-engine company, which is seeking to recover from a turbulent few years marked by five profit warnings, will reveal a pre-tax deficit of £4bn for 2016, when it reports annual results on Tuesday.

Despite the headline loss, underlying profits before tax are expected to be ahead of the market’s consensus forecast of about £687m, still down from last year’s £1.4bn.

The news comes just weeks after Rolls-Royce admitted a string of bribery and corruption offences stretching over 24 years to 2013. It reached a settlement with regulators in the UK, US, and Brazil last month in return for a suspension of prosecution, conditional on implementing new compliance measures. The UK share of the £671m fine, at £497m, is the largest ever imposed on a company for criminal behaviour.

Although the UK fine will be paid over five years, Rolls-Royce will take a charge for the whole figure in 2016’s numbers.

Weaker sterling since Britain voted to quit the EU is also forcing Rolls-Royce to write down the value of its $35bn hedge book by more than £3bn.

This will be the first headline loss since 2008, when the company’s reported pre-tax deficit came to £1.9bn. The loss is not expected to affect Rolls-Royce’s ability to pay dividends, according to people with knowledge of the situation.

Underlying pre-tax profits are more closely examined by investors, however, and exclude one-off charges, impairment to goodwill, and other non-cash items. The roughly £700m the company is expected to report at the underlying level on Tuesday compares with £1.4bn last year and would be the lowest since 2005.

Warren East, chief executive, last month sought to soften the blow over the scale of the regulatory settlement by offering news that profit and cash flow had finished 2016 better than expected.

However analysts were sceptical that the outperformance would be significant enough to deliver a sharp bounce in sentiment. Zafar Kahn, analyst at Société Générale, suggested that the cash inflow would fall to between little more than break-even and £100m, against expectations of a £100m-£300m outflow. “In the scheme of things that is not really a game changer in any way, shape or form,” he said. The challenge for a company that has long had volatile cash flow would be to generate net cash on a sustainable basis, he said.

Mr East, who became chief executive in July 2015, has in the past said that 2017 would mark a turnround in the group’s cash flow generation.

However he has also always stressed that his plan to simplify the group, improve its reporting and management structures, and boost its margins would take several years.

On Tuesday he is expected to tell investors that his transformation programme is on track, despite continued challenges in the marine division and a slowdown in the market for widebody aircraft. However the group is expected to deliver its planned £150m-£200m cost savings by the end of 2017, some £30m-£50m of which will have been delivered in 2016.

Rolls-Royce is also facing a significant challenge when new accounting rules come into force in 2018. Last autumn the group revealed the new rules on revenue recognition would have reduced 2015 operating profit by £900m, had they been applied. Rolls-Royce will not provide a pro forma for 2016 until later this year.

Via FT