The Rolls-Royce (LSE: RR) share price has dipped by a third since the start of 2022. But investor appetite for the FTSE 100 stock is recovering sharply and it’s risen 20% in value in the past month alone.
Are Rolls-Royce shares finally on a flightpath to long-term recovery? And should I buy the business today?
Bouncing back?
A variety of headwinds have battered the engine builder this year. While the airline industry continues to recover, supply chain issues, inflationary pressures and the war in Ukraine have smacked Rolls-Royce hard. Indeed, jaws dropped in August when it announced a £1.6bn loss for the first half.
However, hopes that the worst could now be over have gained traction more recently. And Rolls’ announcement last week that it still expects to meet 2022 guidance have further eased market nerves.
In that trading update it said that large engine flying hours have kept improving too. These were at 65% of pre-pandemic levels during the four months to October. Continued improvement helps drive revenues from long-term service agreements (or LTSAs).
Trading has also been strong in other parts of the group. Order intake at Power Systems in the year to date sits at record levels.
Meanwhile, Rolls’ Defence unit has also sealed contracts worth $1.8bn in aftermarket revenues for the next five years.
2 BIG threats to Rolls-Royce shares
Many Rolls-Royce investors would have feared the worst leading up to last week’s statement. So, in that respect, the announcement could be chalked up as a victory.
But as a potential investor there was little-to-nothing in there to encourage me to invest. In fact, it highlighted several ongoing threats to the engineer’s recovery. These include:
1. A lumpy civil aerospace recovery
Okay, engine flying hours are continuing to improve. That’s thanks to a solid recovery in the US and European travel markets. But the Covid-19 pandemic represents an ongoing threat to the business. Indeed, flying hours in China and Asia remain hamstrung by the fight against the pandemic.
Rolls said that shop visits volumes and original equipment (OE) deliveries in the year to date were at the lower end of expectations. They could continue to disappoint too, as the fight against the coronavirus endures and now the weakening global economy weighs on civil aviation demand.
2. Massive debt levels
A murky near-term outlook is particularly problematic, given the company’s enormous debt levels. A whopping £2bn worth of asset sales have helped to reduce the load. But Rolls still has around £4bn of drawn debt outstanding.
The only good thing is that its debts are secured on fixed interest rate terms. If the business fails to get this paid down, the company could struggle to find its capital-intensive long-term growth programmes that are critical for earnings growth.
The verdict
I worry that the recent rally in Rolls-Royce’s share price is built on shaky foundations. Conditions in civil aviation are still improving for sure. But there remain huge problems here that threaten the company’s post-pandemic recovery. I’d rather buy other UK shares for my portfolio.
