Few price charts I find quite as disheartening as that depicting Rolls-Royce (LSE: RR) shares. The company has endured a dreadful period of declining sales, loss-making divisions, senior management changes and company layoffs. Each time commentators and investors alike have predicted a potential turnaround, they have been disappointed.
So, what is different this time?
Rolls-Royce has invested vast amounts of capital to become one of the world’s largest aero-engine makers. It now enjoys some 50% of market share, mostly for wide-body aircraft. Surprisingly, Rolls-Royce sells its engines to airlines for a loss. The profits come from lucrative long-term service agreements where the company gets paid for each hour the engine is in the air.
The pandemic has meant that aircraft manufacturers have halted or delayed bringing new aircraft types to market. Consequently, Rolls-Royce does not have to spend resources designing and manufacturing new engines. Rather, I conclude, it can now enjoy the benefits of a resurgent demand for air travel with less capital expenditure deployed on expensive research and development.
But it’s not all about engines
There are other facets of the Rolls-Royce product line that I see as benefiting from global macroeconomic trends. Building on its experience of manufacturing nuclear reactors for submarines, Rolls-Royce is ready to bring that expertise to constructing small modular nuclear reactors that cost a tenth of more conventional nuclear power stations. With many nations striving to pursue a zero-carbon energy policy, nuclear power is now enjoying a revival. Rolls-Royce claims its first “mini-nuke” could be online by the early 2030s.
Similarly, its defence arm is set to benefit from an increasingly unstable world. As a leading supplier to governments on both sides of the Atlantic, I see these long-term contracts guarantying steady cash flow into the company.
Let’s not lose sight of the challenges
Despite all the positive signs for a potential turnaround, I must remind myself that Rolls-Royce still faces the same challenges many other companies do, namely cost inflation and supply chain disruptions. Additionally, this is a company that is not paying any dividends. In fact, it is barred from doing so until at least 2023 as part of its loan terms. Therefore, I am reliant on capital gains should I choose to invest.
If this is the beginning of a Rolls-Royce renaissance, I want to be a part of it
To my mind, this historic company continues to push boundaries in terms of engineering, technology, and design. The fact that it continues to do so despite all the challenges it has faced is testament to its heritage. I do not know if its share price will now recover, but I do know that I want to buy when it does.
