Rolls-Royce engine starting to sputter

Marlborough Stirling; Manganese Bronze

Investors who backed companies in the aviation sector when it appeared at risk of extinction after 11 September have had their faith amply rewarded. A succession of upbeat announcements from airlines and engineering groups in recent months has seen aviation stocks deliver stunning returns lately. Only last week, the low-cost carrier Ryanair said it was shelling out £6bn for 150 new planes, and yesterday it was Rolls-Royce's turn to hog the limelight with the disclosure of a $250m (£172m) contract to maintain Air Canada's fleet of Airbuses for the next 15 years.

But Rolls-Royce shares rose only 1.75p to 170.25p on this occasion, and it's not hard to see why. Since October, the stock has gained 39 per cent thanks mainly to industry data showing a bounce back in airline passenger numbers. While the most pessimistic forecasts for the aviation industry now look misplaced, investors are rightly beginning to temper their recent optimism with realism.

After all, passenger traffic is still well below its historic averages and, if the Gulf war is any indicator, the numbers are unlikely to register a full recovery for another couple of years. An upturn in new jet orders is even further off.

Planes are generally taking off and landing less frequently, with fewer passengers on board. That has lengthened maintenance cycles. Meanwhile some 1,300 planes are still out of service, idling in various deserts around the world.

Against that backdrop, it becomes very hard to see when Rolls-Royce will see any upswing in orders to make engines for new jets. Airlines will doubtless be taking advantage of the difficult market conditions to strike maintenance contracts at bargain basement prices. Indeed, the company, which is chaired by Sir Ralph Robins, was coy as to the likely margins on its deal with Air Canada yesterday. If it secures similar deals in the months ahead investors should remember that it is the customer, rather than the company, that is likely to have dictated the terms.

Deutsche Bank forecasts pre-tax profits of £442m for 2001, with earnings of 19.25p a share, falling to £305m and 13p in the current financial year. While earnings growth should return in 2003, the level of uplift is difficult to predict. A dividend yield of 5 per cent offers some degree of protection amid the uncertainties, but the shares look likely to drift southwards from these levels.

Marlborough Stirling

IT IS hard to find three sectors with more contrasting temperaments than software, property and life assurance, but they have come together with sparkling results at Marlborough Stirling.

The technology tiddler saw its shares hit a high of 238.5p yesterday upon confirmation that its performance in 2001 was in line with market forecasts, and news that cost savings from September's acquisition of rival Exchange FS would exceed the £3m earmarked when the deal was struck.

Marlborough Stirling specialises in software and outsourcing for providers of investment products, life assurance and mortgages. With sales of life cover and home loans having boomed over the past year, the financial services industry has turned to the company for help satisfying demand without taking on more staff and jacking up costs.

Despite the shares' latest gain, they remain cheap relative to the software sector. UBS Warburg, the house broker, anticipates pre-tax profits of £14.7m in 2001, rising to £21.8m in 2002 and £34.2m the year after, putting the shares on a forward price-earnings ratio of 39, falling to 26 and 21. All the same, they look expensive set against the wider stock market, and the valuation can be justified only on the view that earnings are as predictable as management claims. Since floating in April last year, the company has avoided the warnings that have spewed forth from other technology companies. But there was no news yesterday on current trading, and investors should hold back until a clearer picture emerges at March's annual results.

Manganese Bronze

A deal to produce the TX1 black cab in China with the country's largest maker of petrol engines rescued the taxi designer Manganese Bronze from the doldrums earlier this month, but the stock market paused for breath yesterday.

The vehicles side of the company may be booming, but its components business has had a difficult time in the first financial half-year, due mainly to a single unprofitable contract. Meanwhile, Zingo – a project to develop technology for hailing your nearest taxi from a mobile phone – has encountered delays, although Manganese Bronze does not expect the cost of the programme to go beyond the £8m already forecast.

The disclosures sent the shares down 10p to 134.5p yesterday, although investors who bought in at 60.5p in November will not be complaining. Analysts expect only a tiny profit before costs associated with Zingo this year, and now could be a good time to lock in some profits from the recent rally.