Rolls-Royce shares are up 10% in a week: is this the turnaround?

Rolls-Royce shares are up on the back of a positive trading report. I am cautiously optimistic that this is the start of a turnaround.

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I bought Rolls-Royce (LSE:RR) shares after the 2020 market crash at what I thought was a low price. It looked like a good turnaround pick in the long term. I must admit this holding has tried my patience. Over the last year, the Rolls-Royce share price is down 40%. It has given back almost all the gains it made after the market crash.

But perhaps my patience is paying off now. Rolls-Royce shares have risen 10% over the last five trading days. Over the last month, they are up 27%. Could a turnaround be starting to take shape?

Are Rolls-Royce engines revving up?

The first thing I do when I see a sizable share price rise is to check that there is a company-specific catalyst for it. To my delight, Rolls-Royce released a trading statement on 3 November 2022, and it was positive. The company’s engines power planes. The more hours they fly, the better, which generates servicing revenue. As of the trading statement date, the hours flown were at 65% of 2019 levels, so they are heading in the right direction. But 2024 still looks like the most likely timeframe for a full recovery.

Putting the civil aerospace division to one side, there were other notes of optimism in the trading update. Two defence contracts were secured in the latest quarter, worth over a billion in revenue over five years. The group’s power systems division recently won contracts to supply engines for armoured vehicles and ships in the UK and Germany, respectively.

During the last quarter, the disposal of a business unit, ITP Aero, was finally completed, and the proceeds used to pay off a chunk of debt. That’s important, as the group took on a lot of debt to stay afloat during the pandemic. The balance sheet will look a lot more secure now.

Small modular nuclear reactors

Despite rising interest rates, inflation running hot, and coronavirus fears lingering, Rolls-Royce is sticking with its full-year guidance. Management thinks revenue growth will be in the low to mid-single digits for the full year. Cash flow will be positive, but only just. That might not sound exciting, but the company was bleeding cash and racking up massive losses not too long ago. A huge restructuring effort, which included thousands of job losses, might be working. The company seems better positioned to translate revenues into profits in the future.

Nuclear power surely has a role in the fight against climate change by complementing intermittent renewables like wind and energy security. Rolls-Royce is developing small modular nuclear reactors (SMR), which should be cheaper and easier to deploy than big atomic power stations. The UK has recently backed SMR technology, and it could be a real winner for Rolls-Royce, but its potential and timeframe are still uncertain. It won’t save Rolls-Royce in the short term.

Rolls-Royce shares turnaround

I am going to say I am cautiously optimistic that Rolls-Royce shares have turned a corner. I am happy to continue holding my position. There is still a long way to go, however. The company’s net debt is still around £5.1bn, most of which is due between 2024 and 2028. The company needs to start generating good amounts of cash quickly, as the clock is ticking.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James McCombie has positions in Rolls-Royce. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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