Last week, Rolls-Royce‘s (LSE:RR) results for the first half of the year were released. Rolls-Royce shares initially fell on the announcement, but have rallied partially since then. However, with the price down 27% over six months and 22% over 12, is the outlook from the results positive enough to make me buy?
Key points from the report
Underlying revenue for the half year was modestly ahead of the same period in 2021. Unfortunately, higher costs pushed down both gross profit and operating profit. Underlying operating profit came in at £125m in contrast to the £307m from the year before.
Profit margins were something I noted with concern. The underlying operating profit margin was just 2.4% for the period, down from 5.9% in 2021. The issue here is that it only takes a relatively small change in revenue or costs from this point forward to swing the company from a profit to a loss.
After taking on more debt since the start of the pandemic, it was promising to see that net debt hasn’t increased significantly from 2021’s H1 levels. At that point, net debt stood at £5.14bn, with it now at £5.16bn.
Positives to take from the report
The company expects to finally receive the £2bn proceeds from the ITP Aero sale in coming months. It has stated that it will use this to reduce net debt. I think this is a great move. The reduction in debt gives me more confidence in buying the stock. I’m less concerned about servicing the debt and cash flow pressures. I’m ultimately less worried about the chances of bankruptcy.
Another reason why I think the results were positive is the outlook offered. The management team held to the stated revenue growth made at the beginning of the year, along with a higher operating profit margin. Given that it missed the targets at half-year stage, the next six months must clearly be rosy in order to make this a reality. Having that support from the people who know the business best does give me confidence.
Risks of buying Rolls-Royce shares now
Unfortunately, there were a few points that didn’t sit well with me. For one, it said that “our Civil Aerospace business is becoming leaner and more agile“. The losses taken on by this division have been large, hence the cuts. But I disagree that a smaller division is a good thing. This area was the largest area of profit pre-pandemic. I’m of the opinion that eventually flying hours will completely recover to pre-Covid levels. So I don’t want a leaner Civil Aerospace arm! I want more investment to grow it back.
The business also spoke of inflationary pressures and supply chain issues. This isn’t new and is impacting the industry in general. But this doesn’t mean that I’ll just shrug my shoulders and buy the stock anyway. The impact of these cost increases will materially hurt profit margins going forward, something that I think could persist well into next year.
Overall, following the results I do see long-term value in Rolls-Royce shares. But there’s still a long way to go. Therefore, I’ll dip my toe in the water and buy a few shares now, but I want to see more progress before committing more cash.
