As a young investor, the Covid pandemic was the first time I could study a major stock market crash and subsequent recovery. Over the 18 months since the first big fall, many FTSE 100 companies have shown signs of recovery and some are trading at prices higher than their pre-pandemic levels. The Rolls-Royce (LSE:RR) share price is up 30% in the last six months. But at 133p, it is trading 45% below its pre-pandemic price of 235p, from February 2020, and 64% below its 2018-highs of 375p. What’s going on and what am I doing about it?
Is this a concern?
Firstly, the airline sector across the globe is struggling. The constant change in rules and new Covid outbreaks are throwing people off vacationing. At the time of writing today, Boeing shares are trading at US$207, 39% below pre-pandemic their US$340 levels. UK-based International Airlines Group was trading at 162p, down a whopping 161% from its January 2020 share price of 423p.
Rolls-Royce’s operations largely involve engine manufacture and maintenance for civil aviation. But with aircrafts grounded in airports for months at a time, there is hardly any need for upkeep. Reports of surging Covid cases in India and China are concerning to me too. This means more travel restrictions and less airport traffic.
The company’s net debt almost doubled from 2020 and was at £4.9bn, according to the half-yearly (H1) 2021 report. But this does not include the sale of Spanish manufacturer ITP Aero for €1.7bn (£1.5bn). This move comes as a result of a restructuring effort to reinstate positive cash flow and focus on other core areas of operations. And these areas look bright in my opinion.
Rolls-Royce’s emerging sectors
The defence and power systems divisions of Rolls-Royce are its two largest contributors after civil aviation. Collectively, they accounted for £2.9bn of the total £5.2bn revenue of the business in H1 2021. Although the company has been involved in defence and power generation efforts for over 50 years now, it has become a huge area of focus in the last few years.
The defence division of the company looks robust with a new 30-year contract with the US Air Force to supply aircraft engines worth US$2.6bn. Rolls-Royce expects the defence order book to cover 70% of expected revenue in 2022.
Similarly, the power generation systems in development look very promising to me. Rolls-Royce launched its small modular nuclear reactor (SMRs) project in November 2020. The company believes that the SMR plants will be integrated into UK’s power grid by 2030 and will be a major power source by 2050. I think the R&D in this area looks very promising. Although there are many regulatory challenges, I think this push could make Rolls-Royce an energy powerhouse in the coming decades.
I think it is worth noting that Rolls-Royce’s shares have gone up a whopping 83% in the last 12 months. But this does not mean the recovery will necessarily continue. There is too much uncertainty surrounding the airline sector at the moment. Even though the company’s emerging areas look attractive, nearly half of its revenue comes from civil aviation. If there is another global shutdown, Rolls-Royce shares could come tumbling down again.
This is why I’ll be watching the company closely over the next month to see market reaction before making an investment.
