As major travel restrictions are eased, planes are returning to the skies and flying hours are rising. Despite this good news, the Rolls-Royce share price is still falling and is already down 30% in 2022 and 70% in the last five years. Is Rolls-Royce positioned for a speedy recovery?
Why are Rolls-Royce shares down?
The company, which manufactures engines for wide-body aircraft, was hit hard by the grounding of air fleets in the last two years.
Rolls-Royce operates on a power-by-the-hour basis where airlines pay a flat fee for each hour the engines are used in the sky. Historically this smoothed the company’s earnings, but has harmed revenues when jets remained on the tarmac.
Alongside this, the Rolls-Royce share price plummeted back in February by the announcement that CEO Warren East would be leaving the company at the end of the year. The boss had untaken a successful restructuring programme and steered the company through tough times. With no successor lined up, the long-term vision for the company remains hazy.
Global travel restrictions are easing and demand for holidays is expected to explode this summer. With flying hours already up 42% from last year, it is clear things are improving for the airline industry. As a result, I am expecting Rolls-Royce to see a rise in its revenue over the coming months.
The FTSE 100 firm also has a substantial foot in the defence industry. Rolls-Royce has won a £2bn contract alongside BAE Systems to help build nuclear reactors and boost the UK’s nuclear deterrent. I believe these reliable government contracts will help steady the firm’s revenue over the coming years.
Rolls-Royce is also increasing its presence in the renewable energy sector – another growing market. The small nuclear reactor project aims to provide low-cost nuclear energy solutions for the UK energy grid. While we will have to wait until 2030 for the first operating reactor, I believe this move shows Rolls-Royce is serious about using its engineering expertise to move into new and exciting industries.
My debt concerns
The engineer has certainly not recovered financially from the woes of the last few years. It was forced to inject £7.3bn into operations through the issuance of new debt and equity in 2020. While a successful restructuring programme and the sale of its Spanish subsidiary, ITP Aero, will ease the debt load, more will have to be done over the next few years.
This high debt load will likely eat away at future margins and decrease profitability. Alongside this, Rolls-Royce is restricted from paying a dividend as part of the terms of some of this issued debt.
What am I doing now?
I can see how the tide is beginning to turn for this FTSE 100 giant. Increasing flying hours and the slight shift towards new markets are all positive signs to me. However, as flying hours have yet to return to pre-pandemic levels, I think there are too many obstacles for the Rolls-Royce share price to make a quick recovery. As a result, I’m holding off from Rolls-Royce for the foreseeable future.