Rolls-Royce (LSE: RR) is one of the world’s biggest aircraft engine manufacturers, but also makes power systems. With the majority of its revenue stemming from aircraft engines, I would have expected the Rolls-Royce share price to increase as global air travel resumes. However, its share price is still down 25% year to date (YTD). Here’s why.
Engine shutdown
When Rolls-Royce released guidance for FY22, many investors were upbeat about it. The engine manufacturer said it expects to generate positive free cash flow for the year ahead. This was seen as good news considering that it has been years since this feat was last achieved. Not to mention, the introduction of the Airbus A350 freighter, which also provides tailwinds. As a result Rolls-Royce’s Trent XWB engines are expected to see an increase in production. Nonetheless, the share price still remains at underwhelming levels. So, why’s that?
Well, one of the biggest reasons that the Rolls-Royce share price has traded sideways is down to the cancellation of 63 Airbus A330-900s. The A330neo’s engines make up a bulk of Rolls-Royce’s engines on order. Consequently, this cuts the number of Trent 7000 engines on order in half. This isn’t helped by the news that an increasing number of airlines may start grounding their A350s as well, due to surface degradation issues. The results of such a grounding could resort to a bigger hit in revenue from Rolls-Royce’s biggest income stream. Therefore, the previous tailwinds have now shifted, because Rolls-Royce now has a fresh set of problems to deal with.
| Engine Type | Airframe | Market Share | Engines in Service | Engines on Order |
|---|---|---|---|---|
| Trent XWB | Airbus A350 | 100% | 764 | 859 |
| Trent 7000 | Airbus A330neo | 100% | 130 | *150 (550 Previously) |
| Trent 1000 | Boeing 787 | 33% | 604 | 122 |
| Trent 900 | Airbus A380 | 48% | 168 | 1 |
| Trent 800 | Boeing 777 | 40% | 176 | 0 |
| Trent 700 | Airbus A330 | 60% | 1,146 | 0 |
| Trent 500 | Airbus A340 | 100% | 92 | 0 |
| Total | 3,080 | 1,073 |
Staying in economy class
Piling on to Rolls-Royce’s misery, analysts from both Morgan Stanley and JP Morgan seem uncertain about the stock. Although Citigroup and Berenberg rate the stock a buy, Deutsche Bank shares the bearish sentiment, reducing their price target of the stock to £1.10. Analysts at JP Morgan cited scepticism towards Rolls-Royce’s future growth plans. The investment bank is not too optimistic about the new markets division at Rolls-Royce. This segment of the business is supposedly meant to build small nuclear reactors and electrical power for small aircraft. Nevertheless, analysts do not believe it will be able to generate a healthy margin of income and bring the share price up in the long-term future. This, paired with a slowing economy, indicates to me that Rolls-Royce is most likely going to face a tough time for the foreseeable future.
Silver lining
There is a silver lining to the strong headwinds, however. Despite Rolls-Royce’s atrocious balance sheet and high level of debt, the company doesn’t have any debt maturities to pay before 2024. This should buy the manufacturer some time to generate some free cash flow. In spite of that though, I do remain sceptical of the business’s prospects for the near-to-medium term, however. With the engine cancellations continuing, the new markets segment a long way from profitability, and stagflation possibly kicking in, I don’t think the Rolls-Royce share price will be going up any time soon. As such, I will not be buying shares for my portfolio.
