Last week’s news triggered a sharp sell-off for the Rolls-Royce (LSE: RR) share price. As I write on Friday morning, the stock is down by 12% in a week.
Russia’s invasion of Ukraine is probably a negative for Rolls-Royce, but the company doesn’t make much money in Russia. I think the real reason for the share price slump is the news that chief executive Warren East plans to leave. I’ve turned bullish on Rolls in recent months, but is now the right time to buy the shares?
CEO departure is a blow
I’m disappointed to learn that East plans to leave at the end of 2022. He’s highly rated by the markets. I’ve been impressed by the way he’s worked through some serious problems since taking charge in 2015.
He’s reshaped the organisation and dealt with serious technical issues on the Trent 1000 engine. He then led the business through the pandemic, cutting more than £1bn of annual costs and raising funds to provide a secure financial base for a recovery.
In the background, Rolls’ defence business has continued to grow, providing stable profits during a difficult period.
Finally, East has increased investment in lower carbon and net zero technologies. The group is now seriously committed and is spending 50% of its R&D budget on this work.
Financial results aren’t there yet
East has probably not been the luckiest CEO. I think he’s done the right things at the right time, but his plans have been delayed by events outside his control.
I think last week’s results reflect this. Although flying hours for Rolls’ large engines in 2021 were 11% higher than in 2020, they were still a long way below 2019 levels. As a result, the group’s civil aerospace business reported a loss of £172m last year. Fortunately, this was offset by profits of £457m in defence and £242m in power systems.
At a group level, Rolls-Royce returned to profitability with an underlying operating profit of £414m in 2021. However, the group continued to burn through cash, with a net outflow of £1,442m last year. As a result, net debt rose to more than £5bn.
East expects cash flow to turn positive in 2022, but was reluctant to give specific guidance last week.
Rolls-Royce share price: can it take off?
Broker forecasts suggest that Rolls-Royce’s earnings per share will rise to 4.8p in 2022 and 7.8p in 2023. These estimates price the stock on 21 times 2022 earnings, falling to 13 times earnings next year.
On a long-term view, I think this is probably cheap. The group remains a world-class engineering business with a sizeable share of key markets.
However, I’m aware there are still risks ahead. We don’t know how quickly long-haul flying will recover following the pandemic. Although Rolls doesn’t generate much revenue in Russia or Ukraine, this conflict may still cause further disruption.
I’m confident Rolls’ recovery will be a success. But I think there’s still some risk of further delays. Although I’d be happy to start buying Rolls-Royce shares for my long-term portfolio, I’d probably buy in stages, in case the share price has further to fall.
On balance, I don’t expect Rolls-Royce shares to lift off rapidly. I think a slow and steady recovery is more likely.
