The Rolls-Royce (LSE:RR) share price has been sliding fast, falling 44% off its 12-month high.
The question weighing on my mind is whether this drop represents something that has gone fundamentally awry with the business, or whether global recession concerns have provided me with a golden buying opportunity? Providing it is the latter, as markets look forward and short-term fears abate, high-growth stocks such as Rolls-Royce will come back into fashion and rebound sharply.
When analysing any share price, it is important to look at where a business has come from and where it is today. That is because 1) today’s price merely provides us with a snapshot of today and taken by itself provides no information to investors, and 2) the share price can often become detached from reality. Just because a price is close to record lows or record highs, we cannot infer success or failure in that one snapshot. Looking at today’s share price alone vs its historical prices, we could infer that Rolls-Royce is struggling badly and is in very nearly the worst place it has ever been. Does this ring true or has the share price become detached from reality? In order to answer this, let’s delve a little deeper into Rolls-Royce’s history.
Then: loss-making…
The Rolls-Royce brand started out over a century ago as a British automobile maker and has, over that period, gone through a raft of corporate restructures.
In 2017, Rolls-Royce posted its largest ever pre-tax loss. This led to huge cuts to the workforce in a mammoth restructure in 2018 where it started to focus on key three segments, namely aerospace, power systems and defence. Weighed heavily by debt, having invested over £11bn in R&D over the decade, as well as poor relative revenue performance, the restructure proved necessary and financially prudent, resulting in some impressive cost-savings for the business today. At that time the market cap of the company was £17bn and the share price was 333p.
Now: profit-taking…
Fast forward to today and Rolls-Royce is capped at just £7bn, trading at 88p. The pandemic naturally proved challenging across the aviation sector and saw the company hit a record low of 36p as it made further cuts to mitigate against reduced flying hours. Despite these challenges, Rolls-Royce is now back in the black and bearing the fruits of its restructure, returning to profitability in 2021.
The business generated £11bn in revenue last year and is trading at close to half of this right now, so this certainly does appear cheap on a relative historical basis – looking at where the business was back in 2017. It should be noted that on a pure price-to-earnings basis the business would still be considered expensive, but to deliver any cash-flow at all right now given the challenges the business has faced is no mean feat.
Of course, the share price could fall further under continued market pressure, additional funding requirements and/or inability to manage ongoing debt – I believe, however, the price is ready to rebound having become detached from the reality of Rolls-Royce, as the underlying businesses are arguably leaner and healthier than ever over the previous five years.
