It’s too early to claim that Rolls-Royce’s (LSE: RR) share price is past the worst. The company still faces significant uncertainty as inflation soars and the world teeters on the edge of another recession.
Rolls-Royce shares tanked in early August due to a negative reception to half-year financials. But steady gains since its recent plunge offer some crumbs of encouragement.
Can the FTSE 100 stock continue to steadily recover ground? And should I buy it for my UK shares portfolio?
Good and bad
First let’s quickly recap Rolls-Royce’s first-half report. The headline takeaway was that it missed broker forecasts and posted an underlying pre-tax loss of £111m. This was due to a mix of inflationary pressures, supply chain constraints, and issues related to Russia’s invasion of Ukraine.
However, on the plus side, Rolls said that engine flying hours continue to improve following Covid-19-related disruptions to the civil aerospace sector. They hit 60% of 2019 levels between January and June. And flying time is tipped by the business to hit 70% by the year’s end.
Patchy recovery
A sustained rebound in the airline industry is critical for Rolls-Royce’s share price. Not only will this support near-term demand for its aftermarket service, a key profits driver at the business, it will also drive orders for new aeroplanes and subsequently aircraft engines, underpinning Rolls’ long-term future.
Worryingly, the outlook for global airlines remains packed with danger, however. With a global recession looming, consumers are reducing leisure spending and business travel is beginning to reverse, too.
Flight cancellations also remain high due to staff shortages, casting a further cloud over flying times. Thousands of journeys have been cancelled so far in 2022, and this week Heathrow extended its passenger capacity limit to the end of October.
Debt worries
The trouble for Rolls-Royce is that its high debt level makes a steady recovery essential. The business had net debt of £5.1bn as of June, and the sum is likely to remain considerable for some time.
This also gives me reason to worry about the Rolls-Royce share price. Soaring inflation means that the Bank of England is likely to keep hiking rates, pushing up the engineer’s debt servicing costs.
Interest rates rose by 0.5% earlier this month, the biggest single hike since 1995. City economists believe an identical increase could be due in September, too. News today that UK real pay has fallen by its largest amount on record will raise the pressure on the Bank to act aggressively in the months ahead.
The verdict
Rolls-Royce is taking steps to reduce debt levels through asset sales and cost reductions. But so far these aren’t putting a dent in total borrowings. In fact net debt crept up again in the six months to June.
Given Rolls’ high debts, then, and the fragile outlook for air travel, I think the Rolls-Royce share price could sink again at any time. I like the steps it’s taking to address the climate crisis by building technology like nuclear reactors and cleaner aircraft engines. But these positives are massively outweighed by the risks the business poses to investors, at least in my opinion.
With the imminent exit of chief executive Warren East adding another layer of uncertainty, I’d rather buy other UK shares right now.
