Why is the Rolls-Royce share price down 8% today?

Rolls-Royce gave investors a trading update today and its share price slumped. What are investors reacting to within the report?

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At the time of writing the Rolls-Royce (LSE: RR) share price is down almost 8%. Earlier today the company released a trading update which will help explain why stock in UK-based engineering company is falling. However, the FTSE 100 is also down around 0.8% so far today. An increased likelihood of a no-deal Brexit seems to be the force driving the market lower.

The Rolls-Royce share price reacts to the movements in the market, in this case, the FTSE 100. Rolls-Royce stock has a beta of 1.7658 with respect to the overall market. That means we would expect a 0.8% down move in the FTSE 100 to cause Rolls-Royce stock to fall by about 1.41%. But, that still leaves some 6.59% of the decline in the Rolls-Royce share price to try to explain. So, let’s turn to the third-quarter trading update.

Rolls-Royce trading update

A major reorganisation program, announced in May 2021, is still expected to deliver £1.3bn in pre-tax cost savings by the end of 2022. There was more good news. Rolls-Royce’s power division is showing signs of early improvement, and its defence business has a full order book for 2021. Engine flying hours are gradually recovering. This is good news for the civil aviation business, which was badly hit by the pandemic.

Rolls-Royce’s CEO, Warren East, reported that the £5bn debt and equity recapitalisation package was well supported and has strengthened the company’s balance sheet. In particular, the company has around £8.75bn in liquidity and expects to end the year with net debt (including lease liabilities of approx £2.1bn) between £3.6bn and £4.1bn.

Rolls-Royce now expects a free cash outflow of £4.2bn in 2020. Previous guidance, made at the half-year point, was for a £4bn outflow. The deterioration in free-cash-flow forecasts was blamed on the second wave of the coronavirus. The company is still optimistic about turning free-cash-flow positive at some point in the second half of 2021. A target of £750m of free-cash-flow (excluding disposals) as early as 2022 remains unchanged along with £2bn of disposal proceeds.

An agreement to sell the company’s civil nuclear instrumentation and control business has been signed. ITP Aero, a jet engine maker, and Bergen Engines, a gas and diesel engines business, are earmarked for disposal. Together these three business sales would comprise the bulk of that £2bn target.

Rolls-Royce share price slide

The overall theme of the trading update was that the second wave of the coronavirus had slowed Rolls-Royce’s recovery. For example, the company was keen to point out that its best guess for engine flying hours for 2020 was 45% of 2019 levels. Up until November, flying hours were at 42%, and had been steadily improving since April’s low point.

Rolls-Royce’s management feels more certain around their forecast of when commercial air travel will return to something approaching normality since coronavirus vaccination programmes have begun. That appears to be why they are confident of hitting that £750m free cash flow as early as 2022.

Since the Rolls-Royce share price is down 8%, shareholders do not seem to have taken the update as positive. They might have focused on the increased free-cash-flow hit for this year. A challenging end to 2020 might be feared to extend deeper into 2021 than Rolls-Royce’s management expects.

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James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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