Rolls-Royce (LSE:RR) shares are trading for around a quarter of where they were in 2019. It’s been an almighty fall for the FTSE 100 stalwart.
The pandemic brought with it a host of challenges for the UK-based engineering giant. Flying hours fell which meant Rolls earned less from its ‘power by the hour’ commercial contracts. There was also a downturn in defence spending as governments focused their resources on Covid-19.
But, as we move on from the pandemic, the Rolls-Royce share price is still pushing downwards. So let’s take a closer look at the company’s fortunes and explore why I’m not putting my money in a 3% savings account, but buying Rolls-Royce shares.
Ongoing challenges
Firstly, it’s worth noting that Rolls still has several headwinds. The company took on a lot of debt during the pandemic and it has recently completed its £2bn raise by selling off business units. Part of this will be used to reduce the company’s debt burden. The business had net debt of £5.1bn as of June.
There are also growing economic challenges. Rolls-Royce engines are widely fitted to aircrafts used on long-haul flights. But with the global economy going into reverse, there could well be less demand for long-haul travel, slowing the post-pandemic recovery.
The bull case
Rolls-Royce has impressive revenue generating capacity. In fact, the firm secured around $15bn in revenue last year, more than double the current market-cap. However, this is considerably down on the $21bn generated in 2019.
The big challenge is returning to pre-pandemic levels of profitability. In the six months to 30 June, the group said underlying operating profit fell to £125m from £307m in the same period a year ago. Rolls highlighted that this was partially due to £371m of research and development costs with an increase spend in Defence and Power Systems.
But there are several reasons to be positive. Firstly, the civil aviation industry is returning to pre-pandemic levels. It’s not there yet, but flying hours are certainly increasing quarter by quarter, and this will have a big impact on revenue generation.
Longer-term trends are also positive too. Aviation has some huge growth markets including fast-developing nations like India.
The company also has a strong order book in its other sectors, Power Systems and Defence. And that gives it good visibility going forward. Defence is also likely to be boosted further as new prime minister Liz Truss wants to see UK defence spending hit 3% by 2030.
And, more generally, it’s important to note that Rolls-Royce operates in industries that put a high price on quality. And this creates high barriers to entry. Yes, the company already has competitors in the West, but I think we’re unlikely to see firms in developing countries start to challenge Rolls here.
Currently trading below 80p, I see now as a great time to buy more of this stock for my portfolio. And I believe that my returns will be greater than a savings account over the next year.
