Aeronautical engineer Rolls-Royce (LSE: RR) has been one of my more disappointing shareholdings this year. The Rolls-Royce share price this week was at times less than half its level at the beginning of 2022.
But as a long-term investor, I try not to pay too much attention to short-term swings in a company’s share price. Instead, I look at what I see as the longer-term prospects for the underlying business. On that basis, ought I to increase my Rolls-Royce position now in the hope of price recovery?
Business performance looks promising
Last month, the company announced it had completed the sale of ITP Aero at an enterprise value of approximately €1.8bn. The company plans to use the proceeds to help reduce its debt load. Especially at a time of increasing interest rates, I see that as positive for the Rolls-Royce balance sheet.
The most recent indication of how the business is doing came in August, when Rolls-Royce published its interim results. At that point, the company said it expected “good (previously modest) revenue growth and improved profitability as well as a substantial improvement in trading cash flow” this year compared to the previous 12 months.
Revenue, gross profit and operating margins all grew in the first half compared to the prior year period. Although free cash flow was negative, the outflow was much reduced compared to the same six months the year before.
One negative aspect was a large loss of 19.3p per share, compared to earnings of 4.7p per share in the same period a year before. Operating profit actually grew, but substantial finance costs pushed the company to a loss overall.
On balance, I think the first half results show that the business is recovering. I do see the need to pay down debt as an ongoing risk to profits. But, as the ITP Aero sale shows, the company seems well aware of that and is making significant moves to improve its balance sheet.
Why has the Rolls-Royce share price fallen?
But if the business performance is improving, why has the share price moved in the opposite direction? I think the company has suffered from a broad fall in enthusiasm among investors.
Its multinational business means that a weakened pound could hurt profitability badly. Ongoing travel restrictions in some markets, combined with rising living costs globally, could hurt demand for civil aviation. That might lead to reduced revenues for Rolls-Royce. When planes with its engines fly fewer hours, they are serviced less often.
Why I’d buy
But I see these as essentially short-to-medium-term challenges. The underlying business trend for the company looks to me like one of recovery. It has a leading position in a market with few competitors and high barriers to entry. While the Rolls-Royce share price is in pennies I see it as a potential recovery play for my portfolio.
I already have a sizeable stake, so do not plan to buy more shares at the moment – but will keep the ones I have in the hope of ongoing recovery and future growth potential.
