This year has been a better one than 2020/2021 for Rolls-Royce (LSE:RR). Still, the share price is down 22% over the past year. Despite positive developments, it appears investors still aren’t massively optimistic about the business right now. I sit in this camp as well, with several reasons why I’m not going to be buying Rolls-Royce shares right now.
The elephant in the room
One point of concern I have is with the state of the balance sheet. The business is working hard to reduce debt, with the cash proceeds from the ITP Aero sale (£2bn) being used to pay off some of the that hefty pile.
However, the company still sits with around £4bn of debt outstanding. In a recent trading update, it noted that it can draw on £5.5bn of credit facilities via banking partners. Although this is good, it doesn’t help to solve the problem long term. if it draws down and utilises some of the £5.5bn, this ultimately needs to be paid back. If anything, it gives Rolls-Royce a false sense of security regarding cash management and paying down debt.
We’ll have to see what the full-year financial results offer us, but the half-year figures posted a loss of £188m. So there isn’t a large profit that can be used to fund paying down liabilities anytime soon. As a result, I think the burden of interest/coupon payments is going to be a continued drag on fiancial performance in 2023 and beyond.
Dealing with inflation
Another issue I have is in dealing with cost inflation. This isn’t an issue that’s unique to Rolls-Royce, but I’m not convinced about the strategy to deal with it.
For example, it noted that “many of our long-term contracts contain inflation-linked pricing clauses”. Sure, it can pass on the rise in price to clients on the existing contracts. But how many of these are going to be happy about this? Won’t this cause them to look elsewhere for new contracts in the future?
For staff, the business has agreed a 6.5% wage increase in October and a £1.5k bonus payment. I respect this gesture, but the wage increase means that from now on, the labour cost has gone up by 6.5%. That’s why other companies are focusing just on one-off payments. This avoids the long-term rise in labour costs associated by bumping up salaries.
I don’t feel like the company has been that smart in measures to handle inflation.
Thinking about the shares
I accept that some will disagree with my view. I can point to the recent record order intake in Power Systems, or the recovery in large engine flying hours (now at 65% of 2019 levels).
When I look where the share price currently trades, it certainly could be a good value stock to hold for a long time. Yet based on my above thoughts, it just doesn’t quite sit right with me at the moment. I won’t be buying.
