The UK is expected to enter a recession later this year. The Bank of England anticipates this could last well into 2023. Not all companies do badly in a downturn, as their strength or weakness depend on the sector and the type of customers involved. Given that Rolls-Royce (LSE:RR) has a range of revenue streams from defence to civil aerospace, here’s how I think Rolls-Royce shares could handle a recession.
Benefiting from the restructure
A recession is technically two quarters of negative GDP growth. The other key elements that usually come with a downturn relate to higher unemployment, lower consumer spending and low investor confidence.
In terms of higher unemployment, headlines about companies laying off staff are negative for the share price. For Rolls-Royce, I don’t actually think the business will need to cut back in this regard. Over the past couple of years, it’s been going through an extensive restructure anyway.
Back in the middle of 2020, it announced 9,000 job cuts. The business is now a more efficient, streamlined operation than it was a year or so ago. Therefore, although it’s not a perfect company, I don’t see it needing to make further large job cuts due to a recession. This would be a good thing for the share price.
A good customer base
During a recession, we all tighten our belts when it comes to spending. For Rolls-Royce, it doesn’t sell directly to consumers, so the impact is softened.
For example, in the latest results released last month, the business spoke of the strong order book for the defence division. Its customers are mainly government departments, with new US military contracts announced earlier this week.
Of course, governments will also need to trim spending in some areas during a downturn. But this isn’t to the same extent as ordinary people. It’s also unlikely to cut back on key areas like defence.
So I think that if anything, the reliance on governments and corporates as customers is actually a good thing for Rolls-Royce shares.
My take on the shares
I don’t actually think that Rolls-Royce will suffer during the recession as much as other sectors. The risk to my view stems from the civil aerospace division. The fate of this arm is largely determined by how well the aviation sector does in general. If fewer people fly for pleasure or business during the recession, this will lower flying hours. That will negatively impact the need for servicing and other offerings from Rolls-Royce.
It’s also true that the share price is already down 30% over the past year. Over three years, the loss is 75%. So there does come a point at which the share price will struggle to materially fall further unless it’s going bankrupt.
I think that the looming recession isn’t a huge issue facing Rolls-Royce. I’m keen to invest small amounts regularly over the next year in the business, targeting a longer-term move higher.
