The aerospace sector is one of many to have been heavily disrupted by the pandemic and has consequently wreaked havoc on the Rolls-Royce (LSE:RR) share price. Why? Because the engineering company generates almost half its total revenue from the airline industry alone. And when most flights worldwide are grounded, all the income from selling and maintaining aircraft engines vanishes.
But since its lowest point in October 2020, the Rolls-Royce share price has climbed almost 180%! Will it return to its pre-pandemic levels in 2021? And should I be considering the company as a value investment for my portfolio? Let’s take a look.
Why is the Rolls-Royce share price rising?
There are two primary catalysts for the recent surge in the Rolls-Royce share price, as I see it. The first is a rescue package. In October, the firm announced it had successfully avoided disaster with £5bn of additional financing by issuing bonds and rights issues.
The second seems to be some resemblance of normality returning to the aerospace sector. The UK government has recently laid out its plans to ease lockdown restrictions. Within the proposed roadmap, holiday travel is set to resume mid-May this year, just in time for the summer holiday season. While this is still a few months away, several airlines – including EasyJet and TUI – have reported a massive surge in flight and package holiday bookings.
Needless to say, this is excellent news for Rolls-Royce, and so its share price has taken off. But is it a good value stock?
A business in distress
While the impact from Covid-19 has been devastating on the Rolls-Royce share price, the company was in trouble long before the pandemic hit.
In four of the last six years, it has been losing a significant amount of money. This ultimately forced it to raise additional capital with debt throughout that period and severely damaged its financial health.
Before Rolls-Royce raised the additional £5bn, the stock had nearly £8.8bn of debt on the balance sheet. By comparison, the market capitalisation of the entire company is only around £9bn. This means the total level of debt of this business is now greater than its market value. And a highly-leveraged, unprofitable business in distress is a serious red flag in my eyes.
Value stock or value trap?
The return of holiday travel is undoubtedly good news for the Rolls-Royce’s share price. And I think it’s likely to continue climbing provided that the UK government’s roadmap doesn’t get changed (which is entirely possible).
But even if all performance expectations are met, I believe the business is still in lots of trouble. It was struggling to stay on top of its interest payments before the pandemic. And now it has another £5bn of debt to deal with. So personally, this is not a business I want to own. Given the challenges that lie ahead, the risk does not match the reward, in my eyes.
