Rolls-Royce (LSE: RR) stock has been on fire the last few months. In fact, since bottoming out in October last year, the stock has more than doubled. It’s up over 50% in 2023 alone, as investors have become bullish about the engine maker’s turnaround potential.
However, over a five-year period, the stock is still down by 51%. So is it a screaming buy for me today at 154p?
Encouraging full-year results
Rolls-Royce’s engines power some of the largest jets in the skies. So when the pandemic grounded the global civil aviation industry, the engineering giant could have collapsed. To survive, the company was forced to shore up its balance sheet with a colossal amount of new equity and debt.
However, there were some encouraging signs in last year’s results. Net debt was reduced by nearly £2bn over the course of the year, leaving it standing at £3.3bn. It should be noted, though, that this reduction was mainly delivered through cash it raised from the disposal of assets.
Free cash flow from continuing operations improved to £500m in 2022, from an outflow of £1.5bn in 2021. This was helped by 35% growth in large engine flying hours.
Moving forward, the reopening of Chinese airline flights is obviously massive for Rolls-Royce. China represented around a quarter of total engine flight hours in 2019 prior to Covid. The company is paid by the hours that its engines are in the air, so the fact that it now expects flying hours to return to 80%-90% of pre-pandemic levels this year is extremely encouraging.
A new direction
Tufan Erginbilgic became Rolls-Royce’s new chief executive at the start of this year. Before joining the engine maker, he spent 20 years in executive roles at BP. There, he helped deliver cost reductions and boosted earnings. In fact, Barclays once described his turnaround of BP’s struggling downstream operations as “Tufantastic”.
He is committed to returning Rolls to an investment-grade credit rating, whereupon it will resume dividend payments. A large part of this will involve continuing to improve its balance sheet.
However, significantly reducing the firm’s debt from here will likely prove more challenging. There’s only so many assets it can sell off, after all.
The future is still uncertain
The company is developing many still-unproven green technologies such as electric, hybrid and hydrogen propulsion. Then there’s its small modular nuclear reactors (SMR) business. Will it continue to invest — and potentially keep losing — money in these long-term projects?
I think it obviously needs to in order to position itself for a net-zero world beyond fossil fuels. But unlike BP, which is investing billions in future green projects, the engine maker is doing so from a much weaker financial position.
For instance, Rolls-Royce says its £500m SMR programme will run out of cash by the end of 2024. What will happen then if the government doesn’t rescue or subsidise it?
Erginbilgic is known for setting out a very clear operational direction. So I’m sure investors will find out sooner rather than later.
In the meantime, I’m going to keep the stock on my watchlist, especially after its explosive rise lately. There are too many uncertainties at the moment for me to call this a screaming buy.
