Rolls-Royce shares are nudging higher. Should I buy now?

With Rolls Royce shares edging above 120p this week, is the worst behind it? Dylan Hood investigates the long-term potential of this stock.

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We’re all aware of the pandemic roller coaster that Rolls-Royce (LSE: RR) shares have been on through the last year. At just above 125p a year ago, they then peaked at just below 140p in June before dipping below 40p in October. The share price has certainly kept investors on their toes. However, is the worst behind it?

Pandemic losses

2020 left Rolls-Royce with a loss of almost £4bn. Rolls makes the majority of its money servicing aeroplane engines, an industry largely curtailed by Covid travel restrictions. In an effort to reduce its cost base, the firm slashed 7,000 jobs, in line with what boss Warren East described as “the largest restructuring in our recent history”.

In October 2020, 6.4bn new shares were issued in an emergency move to raise new capital. Shareholders were able to purchase 10 new shares at 32p each for every three shares they owned. Though this raised £2bn, Rolls-Royce shares halved in value as a consequence, slumping to a 15-year low. This also drastically reduced the earnings per share, a key valuation metric for stock performance.

Pre-pandemic problems

Rolls-Royce shares were troubled even before the pandemic. In 2019, the company had to fork out £800m to remedy ongoing durability problems relating to the Trent 100 engines. This raised the total cost of Trent engine problems to £2.4bn for 2017-2023. Rolls therefore upped spending to get grounded aircraft back in the sky. This put excess strain on cash flow, which was magnified tenfold when the pandemic struck.

Rolls-Royce shares’ future outlook

But while 2020 proved disastrous for Rolls-Royce shares, it’s not all bad news. The company is planning to construct 16 mini-nuclear power plants as part of its small modular reactor programme. It’s expected to receive £200m towards the project from the UK government. Projects like these are essential to the UK if it wants to reach its target of zero emissions by 2050.

And with Covid restrictions easing daily around the world, the travel sector is poised for huge growth in coming years. This is good news for Rolls, as it expects hours flown by its engines to increase 80% by 2022. For example, TUI still has 2.8m holidays booked for this summer, which will be delivered by Boeing 787 Dreamliners. These planes are powered by Rolls-Royce Trent 1000 engines.

Civil aerospace accounts for a dominant slice of Rolls-Royce business. However, Rolls-Royce Defence actually saw growth of 8% throughout 2020, generating an underlying profit of £448m. Also, its Spanish subsidiary ITP Aero, which manufactures niche aero engine and gas turbine parts, made £68m profits. These ventures may help bolster Rolls-Royce shares’ future value.

My Verdict

The aerospace sector was decimated by the pandemic. Though cost-cutting and restructuring did take place, the truth is the company’s balance sheet is still shaky at best.

The pandemic still isn’t over and a sluggish restart of global travel could continue to dent the business, whose share price was declining even before 2020. While the current share price rise may look enticing, there’s still a lot that could go wrong. Therefore, I won’t be adding Rolls-Royce shares to my post-pandemic portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Dylan Hood owns no 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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