The last 10 days have been a pretty bumpy ride for the Rolls-Royce (LSE:RR) share price. Despite management reporting promising full-year results, the stock has been on a downward trajectory. And consequently, the shares have fallen by more than 20% in the last 12 months. By comparison, the FTSE 100 is up by just over 5%. Is this a sign to run for the hills? Or am I potentially missing out on a fantastic buying opportunity for my portfolio? Let’s explore.
Can the Rolls-Royce share price recover?
I’ve looked at this business several times before. And each time, my primary concerns surrounded the level of exposure to certain industries (primarily aerospace) and the unhealthy-looking balance sheet. Yet despite what the recent tumble in the Rolls-Royce share price would indicate, both of these problems seem to be getting resolved.
In 2020, the majority of its income stemmed from the sale and, in particular, maintenance of commercial aircraft engines. So, when Covid-19 led to closed borders, the revenue stream pretty much evaporated. Today, the pandemic has loosened its grip on the world. And the travel sector as a whole seems to be heading back in the right direction, along with the firm’s income.
But what’s encouraging is the group’s no longer overly dependent on a single industry. Its Defence and Power Systems divisions now represent 56% of the revenue stream, up from 44% in 2019. Some of that’s due to other ops contracting in the pandemic, but they’ve also seen growth themselves.
What about the balance sheet? After some fairly aggressive restructuring that unfortunately saw 9,000 employees lose their jobs, Rolls-Royce has cut annual costs by £1.3bn. Its capital outflow last year still came in at around £1.5bn, resulting in an increase in net debt. But with the upcoming £2bn sale of its ITP Aero business, a good chunk of these financial obligations, and in turn, interest payments are due to be wiped out.
With that in mind, the Rolls-Royce share price looks like it could have some promising years ahead. But as always, there are some risks that could derail its progress.
Taking a step back
Given the seemingly promising results, it raises the question of why the Rolls-Royce share price fell so sharply recently. The catalyst appears to be the surprise departure of CEO Warren East. At the end of 2022, he will no longer be steering the ship, and management now has the arduous task of finding a suitable replacement within the next nine months.
While I’m sure the company will find plenty of qualified candidates, performing a CEO hunt in the middle of a recovery strategy is a pretty big distraction. Needless to say, that’s not what I like to see when prospecting a company as a potential addition to my portfolio.
If the wrong person is appointed or management starts taking its eye off the ball, I wouldn’t be surprised to see the Rolls-Royce share price suffer.
The bottom line
All things considered, I think the worst is now over for Rolls-Royce as a business. The company appears to have made several prudent decisions that are already having a positive impact on its health and future potential. At least, that’s what I think.
But personally, I’m going to wait and see what’s happening with the leadership change before buying any shares for my portfolio.
