The Rolls-Royce Holdings (LSE: RR.) share price has climbed 40% in the days since full-year results. So we’re surely not going to see a crash in 2023, are we?
I don’t think we’re likely to, no. But there are dangers, and investors shouldn’t just assume it’s only up from here. There really could be more volatility ahead.
Just look where we were back in October 2021. The Rolls-Royce share price had recovered to about where it is today. But it went on to fall more than 50% over the following 12 months.
It might not have been sudden, but that was a fall of crash-level proportions, for sure. Could it happen again? Yes, I reckon it could. Let me explain why I think so.
Problems not gone
Things have definitely improved for Rolls-Royce over the past year. Its problems have eased, clearly. But those problems have most certainly not gone away.
Look at debt, for example. Over the past year, Rolls managed to get its net debt down from £5.2bn to £3.3bn. That’s massive. But it was mostly funded by disposals, and those aren’t sustainable.
The same disposals won’t be there next year. What if we don’t see sufficient cash generation making up for it, and debt doesn’t fall further as quickly as we hope? Well, investor sentiment can change in the blink of an eye.
Debt repayment
Aspects of Rolls’ debt situation make me optimistic though. The company paid off its £2bn UK Export Finance-backed loan in September 2022, which wasn’t due until 2025. That suggests two things I like a lot.
One is that debt repayment is a high priority. In the same situation, I’m sure some would have hung on to such a favourable loan and used the cash for other things. Maybe even paying premature dividends to sweeten the big City investors.
Cash flow
It also suggests confidence in recovering cash flow, and that the company’s operations can hopefully generate the necessary funding.
In fact, the Rolls-Royce board expects to rake in between £0.6bn and £0.8bn in cash flow in the current year. I find that impressive at this stage of the aero engine maker’s recovery.
But there’s still a long road ahead, and investors will need to be patient. Right now, we’re seeing an exuberant reaction to better-than-expected results. That’s to be expected. And shareholders deserve a bit of cheer.
Waiting game
But sentiment is fickle, and the waiting game might not prove sufficiently exciting. What if that cash flow recovery comes in below expectations? It might still be perfectly fine, but shareholders might dump again.
I think Rolls-Royce shares will really start to look safe once progressive dividends are reintroduced, and when we see strong cover by earnings and a sustainable outlook.
I believe that will happen, maybe even sooner than expected. And it puts the shares on my potential long-term buy list. But the danger isn’t yet gone, and I think investors should be prepared for more ups and downs.
