With Rolls-Royce (LSE:RR) shares still slumping, the stock is starting to look rather cheap. While the company is still undoubtedly suffering from some of its pandemic woes, the balance sheet has drastically improved in the last 12 months.
What’s more, its cost-cutting initiatives are already bearing fruit. So, it begs the question, why has the engineering giant lost 50% of its market capitalisation in the past year? And is this secretly a buying opportunity for my portfolio?
Investigating the recovery progress
With the bulk of revenue stemming from the civil aerospace industry, it’s not exactly hard to understand why Rolls-Royce shares got pummelled into the ground in early 2020. Since then, quite a lot has changed.
Management has restructured the business, disposing of non-core operations in a bid to raise capital. As of September, the restructuring has concluded following the successful sale of its ITP Aero business for €1.6bn (£1.4bn).
Using the proceeds of its multiple disposals over the last two years, the group has begun eliminating a large chunk of its loan obligations. Even more encouragingly, management has almost fixed the haemorrhaging cash flow problems. Looking at its latest interim results, cash outflow for the first six months of 2022 landed at £68m versus £1.2bn and £2.9bn in 2021 and 2020 respectively.
Almost half of these gains originate from the aerospace industry’s slow but steady recovery. The number of flying hours jumped by 33% so far this year to 60% of 2019 levels. While a long road remains ahead, the outstanding 40% capacity could propel cash flow to new heights, taking Rolls-Royce shares with them.
Time to buy Rolls-Royce shares?
As impressive as the group’s progress has been lately, there are still weak points to be aware of. Wiping off billions from its ginormous pile of debt is a good sign. But even with the proceeds of its disposals, there are still a lot of loan obligations to repay.
Net debt currently stands at around £5.1bn. And with interest rates being hiked up, servicing these debts could prove quite expensive. The group’s revamped cash flow does alleviate some of the pressure on earnings. But it will likely take years before the cracks in the balance sheet are fully patched up.
In the meantime, supply chain disruptions continue to create headaches. Management has ramped up inventory spending to prevent manufacturing delays. Yet, with commodity prices standing tall, this also adversely affects margins.
Having said that, I can’t deny my opinions on this business have drastically improved over the years. The leadership team seem to be making the right moves to get Rolls-Royce and its shares back on track. And with the worst seemingly behind it, I am cautiously optimistic about the future of this stock.
However, the road ahead is still long. And current forecasts indicate the aerospace sector won’t make a full recovery until the end of 2024. That’s why I believe there are far better investment opportunities for me to be found elsewhere.
