There seems to be growing scepticism surrounding its long-term prospects. But are these fears justified? Or is this actually a buying opportunity for my portfolio? Let’s take a closer look
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What’s behind the falling Rolls-Royce share price?
With the bulk of its revenue originating from aerospace engine sales and maintenance, Covid-19 unsurprisingly punched the income stream in the face. Today, the situation has improved. And with flight volumes on the rise, demand for the firm’s services is following suit. So why isn’t the Roll-Royce share price climbing alongside these figures?
There are undoubtedly numerous factors at play. But the primary concern continues to surround the engineering group’s aerospace division. According to the latest investor presentation, Rolls-Royce’s order backlog currently stands at an impressive £50.6bn. And a good chunk of that comes from aircraft engine orders.
As of the end of March, the company had 1,532 of its Trent engines on the order book. Considering these propulsion systems have multi-million-pound price tags, that’s a lot of money.
Unfortunately, reports have emerged that AirAsia X has cancelled 63 A330neo aircraft orders with Airbus, due to financial problems. What does this have to do with Rolls-Royce? The A330neo is powered by two Trent 7000 engines. And if Airbus cannot find a new buyer, up to 126 engine order cancellations could be heading in Rolls-Royce’s direction.
Combining this new threat with existing concerns about the Ukrainian war, the sudden resignation of CEO Warren East, and rising interest rates, I’m not surprised to see the Rolls-Royce share price continue its descent.
There is a silver lining
As horrendous as all this sounds, there are some valid reasons to be optimistic. Firstly, following a rigorous restructuring of the business, the firm’s balance sheet has seen some major improvement.
There are still plenty of cracks to repair. And the net debt, including lease agreements, stands at a whopping £5.2bn. However, with £2bn of capital set to arrive courtesy of its announced non-core asset disposals, this financial position is expected to improve significantly.
Disposals are obviously a non-repeatable source of income and can take time to complete. Fortunately for Rolls-Royce and its share price, none of its loan maturities are due before 2024. That gives management two years to get cash flows back on track to cover the interest expenses of the remaining balance.
Will this happen? Only time will tell. But current managerial guidance indicates the group’s free cash flow will return to the black by the end of 2022. Needless to say, that would be excellent news for the Rolls-Royce share price.
Time to buy?
Despite what its share price would indicate, this business seems to be making solid progress in its recovery. The potentially looming order cancellations are concerning. But with plenty of other revenue avenues to explore, this appears to be a short-term hurdle rather than a long-term catastrophe.
So can the Rolls-Royce share price take off again? I certainly believe so. Having said that, I’m not tempted to add any shares to my portfolio simply because I think there are better investment opportunities elsewhere.