A few years ago, an army of small shareholders eagerly awaited dividend payments from aeronautical engineer Rolls-Royce (LSE: RR). But the Rolls-Royce dividend was axed as aviation demand slumped in 2020 and has never come back.
But the company now looks stronger by the month and the share price is on fire. It has almost tripled in the past year. Could we also see the dividend coming back?
Cash priorities
First, let us go back to 2020. Why was the Rolls-Royce dividend axed?
A company needs to have spare cash to fund such shareholder payouts. In the case of Rolls-Royce, the demand slump meant it needed to shore up its balance sheet. It diluted existing shareholders by issuing a lot of new shares.
Borrowing grew – and the dividend was scrapped.
Improving financial picture
What about now?
Net debt of just under a billion pounds at the end of 2019 had ballooned to £3.6bn a year later – and £5.1bn 12 months after that. By its interim point last year, the company had brought net debt back down to £2.8bn.
That is still substantial and markedly higher than the level before the pandemic. But the direction of travel is encouraging and Rolls has been assiduously tackling its debt pile.
The business has turned free cash flow positive again (to the tune of £356m in the first half) and in the medium term it is targeting £2.8bn–£3.1bn in free cash flows annually.
Dividend prospects
With free cash flow generation on the up – and expected to be significant if the company hits its ambitious targets – what about the Rolls-Royce dividend?
So far, it is not even being talked about. In last year’s final results and again in the more recent interim results, there was no explicit reference to the dividend outlook.
What to make of that silence?
My feeling is that if the company was prioritising a return of the Rolls-Royce dividend, it would be signalling that more clearly to shareholders. After all, management has not been coy about communicating its plans for the company.
Long-term outlook
I could be wrong.
But I would be very surprised to see the dividend restored when Rolls unveils its full-year results next week – and my expectations of a comeback in the next couple of years are low.
Longer term, though – and that is my timeframe when thinking about investing – I think we could see the dividend making a comeback.
After all, if the business really does throw off all that free cash flow, what will it do with it? It could pay down debt. It could make acquisitions, although lately the company has been selling off businesses rather than buying them.
It might also save the money for a rainy day. That might not be a bad idea. A key risk I see with the business (and why I would not buy the shares at their current price) is that a sudden unexpected demand shock outside the company’s control can dramatically affect profitability, as we saw in the pandemic.
Share buybacks could be another option. At some point, though, if the business hits its targets then I expect the dividend to return, although initially I would expect it to come back at a modest level.
For now, though, I think the company is focussed on other priorities.
