Rolls-Royce (LSE: RR) continues to be one of the most popular stocks on the London Stock Exchange. Last week, for example, RR was the fourth most purchased stock on Hargreaves Lansdown.
Should I buy Rolls-Royce shares for my own portfolio? Let’s take a look at the investment case.
Rolls-Royce shares: is the outlook improving?
Rolls-Royce has been hit hard by the Covid-19 pandemic. In its full-year 2020 results, for example, the company reported a loss of £4bn for the year. That compares to a profit of £306m in 2019. Earnings per share came in at -67p versus 5.44p the year before.
The main reason Rolls-Royce has been impacted so badly by Covid-19 is that it generates a large proportion of its revenues from the manufacturing and servicing of commercial aircraft engines. With many planes grounded during the pandemic, sales and profits have taken a hit.
The outlook for Rolls-Royce appears to be improving now, however. Across the world, people are being vaccinated and this means that travel could resume very soon. There is no doubt that demand to travel is high. If we do all start travelling again soon, Rolls-Royce should benefit. Profits are likely to rise. This could boost the shares.
“Looking ahead over the next couple of years, we are encouraged by the outlook for vaccinations and testing and we expect the rebound in global GDP and lifting of travel restrictions to drive our recovery,” the group said recently.
Risks
As always in investing, however, it’s all about risk versus reward. And with Rolls-Royce shares, there are plenty of risks to be aware of.
One is that, at this stage, it’s hard to know how long it will take for the travel industry to fully recover. So, it’s hard to make forecasts about the future.
Recently, Rolls-Royce advised that the near-term outlook “remains uncertain” and “highly sensitive” to the developments of the Covid-19 virus and the related measures taken by governments around the world. It added that in the current environment, near-term financial forecasting is more difficult and the potential range of outcomes wider.
Until the travel industry recovers, Rolls-Royce is likely to continue losing money. This year, City analysts expect the group to generate a net loss of about £210m. The company said in its full-year results that it expects negative free cash flow of around £2bn this year.
Another issue is the debt on the balance sheet. At the end of 2020, the group had net debt of around £3.6bn (including lease liabilities). This adds risk to the investment case. Stockopedia gives Rolls-Royce an ‘Altman Z1’ score (a measure of financial health) of -0.04 which indicates a “serious risk of financial distress” within the next two years. If profits and cash flows don’t pick up soon, the group may have to raise capital. This could hurt the share price.
Finally, it’s worth pointing out that Rolls-Royce does not have a good track record when it comes to generating shareholder wealth. Just look at the share price over the long run. Over the years, RR has been very inconsistent in terms of its profitability, which is not ideal from an investment point of view.
Weighing everything up, I don’t think the risks are worth it here. All things considered, I think there are other, much safer stocks I could buy today.
