The Rolls-Royce (LSE:RR) share price exploded late last week following the release of incredible trading numbers. It’s led some to believe that the engineer could once again become a top stock to buy for passive income.
The FTSE 100 company hasn’t paid a dividend since before the pandemic. But City analysts expect Rolls to begin rewarding shareholders again as trading conditions improve and its balance sheet gets stronger.
Forward yields aren’t the biggest over the next two years. At Rolls-Royce’s current share price around 122p per share, dividend yields sit at 0.2% and 1.1% for 2023 and 2024 respectively. But should I buy the business on the possibility of robust long-term passive income?
A quick recap
Thursday’s full-year results have boosted investor hopes that Rolls-Royce is on track for a strong and sustained recovery.
During 2022, underlying revenues leapt 16% to £12.7bn. This was driven by a 25% jump at its Civil Aerospace division as the recovery in air travel boosted servicing revenues.
Rolls’ underlying profits soared to £206m last year from £36m in 2021 as a result. Free cash flow meanwhile rocketed to £505m, a big improvement on the £1.5bn outflow it recorded a year earlier.
Strong cash generation and asset disposals over the year helped net debt fall to £3.3bn as of December. This was down markedly from £5.2bn a year earlier.
“Signs of strength”
I’ve long been reluctant to buy Rolls-Royce shares because of its high debt levels. The massive liabilities it racked up during the Covid-19 crisis cast a cloud over how it would finance growth projects. As an investor, I was also concerned about how it would impact on future dividends.
So, naturally, the company’s strong improvement has eased my worries. Analysts at Hargreaves Lansdown have commented that “the leaner organisation has shown signs of strength” and added that “if cash inflows continue, the group will be able to keep pushing debt lower, going a long way in restoring our faith in Rolls’ ability to stand on its own two feet”.
Encouragingly, Rolls has predicted higher free cash flow of between £600m and £800m in 2023.
Not out of the woods
However, I haven’t joined the rush for Rolls-Royce shares in recent days. The business still has many challenges to overcome before a successful turnaround is in sight.
Just last month, new CEO Tufan Erginbilgic described the business as “a burning platform” that underperforms its competitors and has a history of making value-destroying investments. That’s according to a recent Financial Times report.
There are also things out of Rolls’ control that could derail its comeback. The travel industry recovery remains fragile as the global economy shrinks and Covid-19 continues in China.
Persistently-high cost inflation and supply chain issues could also damage profitability and further balance sheet improvement.
Hargreaves Lansdown has even suggested it remains too early to expect the engineer to start paying dividends again. It said that “given Rolls are still sporting a negative equity position — meaning liabilities outweigh assets — we’re sceptical about seeing any kind of dividend this year.”
Rolls-Royce is a FTSE 100 share I’m keeping a close eye on. But for the time being, I’d still rather buy other UK shares for passive income.
