Why I’d buy Rolls-Royce shares now

Rolls-Royce shares have been performing very well recently. I believe it can potentially become a great dividend stock going forward.

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Rolls-Royce (LSE: RR) shares have been on fire over the last six months, soaring by 112%. This is in stark contrast to the preceding five years, where the share price is down by 50%.

It hasn’t paid a dividend since January 2020, but I believe the company may be in a position to start offering one again relatively soon.

Below I’ll discuss why I believe this is the case and what I like about Rolls-Royce shares.

What Rolls-Royce does

Established in 1904, Rolls-Royce is currently the second-largest manufacturer of aircraft engines globally. It also makes and distributes power systems for aviation and other industries.

It has further operations in the marine propulsion and energy sectors, and is one of the world’s largest defence contractors.

Revenue was £13.52bn in 2022, hinting at the sheer scale of its operations.

Issues with debt

Before going into what I like about its shares, it is important to discuss Rolls-Royce’s level of debt.

Its financial statements show that net debt is down from £5.2bn in 2021 to £3.3bn in 2022. This seemingly looks like it is heading in the right direction.

However, looking into the details, these are due to its disposals in its shareholdings of Airtanker Holdings Ltd and ITP Aero, for a combined £1.49bn.

The cash generated from these disposals was used to pay the majority of the £1.9bn debt payments it made.

Therefore, it’s difficult to see how Rolls-Royce can further pay off significant amounts of debt without selling off assets. It may take a while for this to be achieved.

What I like about Rolls-Royce

However, there is still a lot to like about Rolls-Royce shares.

Firstly, its results for 2022 were very impressive. After bleeding almost £1.5bn of cash in 2021, Rolls-Royce returned to positive free cash flow in 2022, generating £505m. Management is also guiding for free cash flow to grow in 2023.

Secondly, demand should start to pick up in the aerospace sector. The Chinese border has recently re-opened again after severe restrictions due to Covid. Therefore, we should start to see more planes in the sky. In turn, Rolls-Royce should start to see more revenue.

We have already started seeing the effects of this, with quarterly revenue growing by over 30% in the final quarter of 2022.

Thirdly, Rolls-Royce currently has a market cap of £12.38bn. This is below the amount of revenue it generated in 2022. Considering the positive free cash flow being generated and the resurgence of demand, I believe this makes its shares quite cheap.

Return to dividends

Rolls-Royce does not currently offer a dividend. Due to restrictions on some of its loans, it doesn’t look likely to pay dividends in 2023 either.

However, the financial statements clearly state, “We are committed to returning to an investment grade credit rating through performance improvement, and to resuming shareholder payments.”.

Free cash flow has returned to being positive. Management guidance also states they expect this figure to grow to between £600m and £800m in 2023. Therefore, it is very possible that we can start seeing dividend payments from 2024 onwards.

As someone who likes dividend stocks, this very much appeals to me. So, if I had the spare cash to do so, I would buy Rolls-Royce shares today.

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.

Muhammad Cheema has no positions in any of the shares mentioned. 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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