Back in November, successful vaccine trials seemed to offer a route out of the coronavirus pandemic. Sadly, it soon became clear that there would be no quick fix. One stock that has suffered is jet engine maker Rolls-Royce Holdings (LSE: RR), whose share price has fallen by more than 30% since the start of December.
In an update today, Rolls’ management has warned that additional travel restrictions are expected to delay any recovery in long-haul flying. The firm now expects to see cash outflows of around £2bn this year. That’s double the £1bn figure previously forecast by analysts.
Should I rule out this stock as a possible buy for my portfolio, or should I think about buying while sentiment is poor? I’ve been taking a fresh look.
The big picture
Rolls-Royce jet engines are mostly used on larger, widebody airliners, rather than the smaller planes used for shorter flights. The company now expects its in-service engines to fly 55% of 2019 hours this year. Previously, management had hoped to see flying hours return to 70% of 2019 levels.
This is bad news because much of the firm’s income is linked to flying hours, which trigger maintenance and servicing requirements. Without flying, revenue and profits slump. Rolls also faces the risk that some of its airline customers might go bust, leaving bills unpaid.
Rolls-Royce’s share price has now fallen by nearly 60% over the last year. Sadly, I think that even this big number understates the damage to long-term shareholders’ wealth. This is because Rolls sold £2bn of new shares and raised £3bn in new debt late last year.
Without getting too technical, this fundraising means that one share buys less of the business than it did previously.
Rolls-Royce share price: I’m not losing hope
I realise that I’m sounding pretty gloomy in this article. Are things really that bad? Perhaps not. If I look further ahead, I can see some things I like about Rolls-Royce as a potential investment.
Firstly, I believe demand for long-haul flying will return to something like historic levels. I don’t see Rolls’ technology becoming redundant.
A further attraction is that this is a difficult market to enter. Rolls is one of a handful of companies that can make the big jet engines needed to power widebody airliners. New engines require massive investment — I don’t expect to see any new competitors enter the market any time soon.
Finally, Rolls’ business is bigger than just civil aviation. The group also has two other large-scale businesses, defence, and power systems. These divisions generated a combined operating profit of more than £750m in 2019. I think they will remain valuable in the future.
What happens next?
I think Rolls-Royce will survive and recover. But I can see lots of potential pitfalls too. For my portfolio, this stock is too difficult to judge as a potential investment. Although I often buy shares in companies that are out of favour, I usually restrict myself to businesses that are still profitable and paying dividends.
Rolls-Royce shares don’t tick either of these boxes. For now, I’m going to file this stock in the too difficult pile. I won’t be buying the shares for my portfolio, but I’ll keep watching and may take another look later this year.
