Rolls-Royce (LSE:RR) shares have lost 25% of their value over the past three months. The stock has been declining since late autumn and is down 32% over the past six months. At around 89p, Rolls-Royce is actually trading at a level comparable with its lowest point during the pandemic in 2020. It’s worth remembering that the aviation industry took a huge blow in early 2020, with very few passenger services going ahead as scheduled.
What’s behind the drop?
Aviation is the biggest market for Rolls-Royce and while 2022 is undoubtedly a better year for flying hours, its been bad for orders. The cancellation of 63 Airbus A330-900s is a major reason for this. The Airbus A330neo is a wide-body airliner and engines for the aircraft represent the bulk of Rolls-Royce’s order book. Following the cancellations, the A330neo backlog now only stands at 200 aircraft. This means that orders for Rolls-Royce’s Trent 7000 engines has been cut in half, down to around 400 from 859 at the beginning of the year.
This isn’t good news for a company that needed a bumper year. Flying hours were down by around 50% in the first half of 2020, causing massive damage to the firm’s revenue and leading it to take on more debt. Net debt increased by £1.6bn over the year to the end of 2021. This will put the business in a weaker place. Furthermore, the capacity to achieve future growth may be impacted by pandemic-induced cost-cutting. Cuts to investment and staff culls may have a negative impact on revenue in the future.
Mounting debt and a smaller order book have been compounded by broker concerns. JP Morgan has cast doubt on the profitability of one of Rolls-Royce’s new businesses — its small modular reactors (SMR) division. Nuclear energy doesn’t have a history of being overly profitable, but SMRs could be different. However, analysts aren’t too sure, with some suggesting this won’t be able to generate healthy margins or have a positive impact on the share price.
Tailwinds
2022 is looking like a better year for flying hours. And this is good as Rolls-Royce’s aviation business earns money through flying hours, not just the sale of individual engines and their components. It is not the value of the engines that is calculated, but the flight hours that can be achieved with the engine.
And while net debt climbed from £3.6bn in 2020 to £5.2bn at the end of 2021, Rolls-Royce doesn’t have any debt maturities to pay before 2024. This will give the business time to get back on a positive footing.
Should I buy?
I’m already a Rolls-Royce shareholder and I’d buy more at the current price as I’m confident the business will deliver improved results in the coming years. Naturally the debt is a concern and I’m also unsure about the profitability of its nuclear venture, but I don’t foresee any massive drop-off in the core aviation business.
