What's Wrong at Rolls-Royce, and Who Will Benefit?

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Who Will Profit From Rolls-Royce's WoesAustralia's national airline Qantas (QUBSF) has inspected all the Rolls-Royce (RR) engines on its Airbus A380 fleet, and found oil where it shouldn't be in three of them, Qantas CEO Alan Joyce said Monday, according to Reuters. Meanwhile, last week, one of its Boeing (BA) 747s had an engine problem -- again, thanks to Rolls-Royce. This raises questions about how deep the problems are at Rolls-Royce, and whether it can survive the bad publicity. Regardless of the answers, competitors General Electric (GE) and Pratt & Whitney -- a division of United Technologies (UTX) -- are likely to be the beneficiaries of Rolls Royce's troubles.

Qantas has grounded its fleet of six A380s, and analysts are starting to forecast a decline in traffic for the carrier. Specifically, Deutsche Bank estimated that if the A380s are grounded for six months, Qantas' international passenger numbers would fall by 378,000. In response, Deutsche Bank cut its fiscal 2011 earnings per share forecast for Qantas by 11.5%, according to Reuters.

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What ails Rolls-Royce? Qantas officials suggest that the Trent 900 engine that failed may have "design issues," according to Reuters. Given that both Rolls-Royce and its customers are still in the early stages of figuring out what those design issues might be -- and how to fix them -- the risk to all concerned could be prolonged, possibly for years.

If a solution emerges quickly, the concerns of airlines -- and their passengers -- may fade. Otherwise Rolls-Royce's woes will represent longer-term opportunity for aircraft engine rivals GE and P&W. GE is No. 1 in the industry now, followed by Rolls-Royce, with P&W in third. In the first nine months of 2010, GE generated $12.82 billion in revenue and $2.48 billion in profit from its aviation unit, while the comparable figures for P&W were $9.44 billion and $1.51 billion, according to Reuters.

P&W has a shot at regaining the No. 2 slot thanks to Rolls-Royce's woes. That's because P&W is focusing on selling engines for smaller, single-aisle aircraft, while Rolls-Royce may abandon that segment to focus on repairing its business in the larger, twin-aisled aircraft segment -- planes such as the A380. With less single-aisle competition, P&W may enjoy a gain in market share.

It's too early to tell how all this will affect the stock prices of these participants, but I would expect more bad news for Rolls-Royce and a shot at things looking up for Pratt & Whitney.

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