I now expect the Rolls-Royce dividend to return. Here’s why!

Our writer explains why he thinks the Rolls-Royce dividend could be set for a comeback — but perhaps not for a while yet. So should he buy?

| More on:

Image source: Rolls-Royce plc

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

For shareholders in aeronautical engineer Rolls-Royce (LSE: RR), part of the appeal used to be the dividend.

The shareholder payout was axed during the pandemic and has not come back. But some comments in the company’s latest shareholder report have made me think things might change in the next several years.

Change in tone

I have previously explained why I was not hopeful about the short-term prospects for a restoration of the Rolls-Royce dividend. Despite improving business trends, rising free cash flow and ambitious financial targets, company management was not even mentioning publicly the prospect of bringing back the dividend.

Since then though, that has changed.

In its annual report published in February, the company identified “a commitment to reinstating and growing shareholder returns” as one of “three clear priorities” in its capital framework.

It explained in more detail: ”When the Board is confident that the strength of the balance sheet is assured and we are comfortably within an investment grade profile, we are committed to reinstating and growing shareholder distributions”.

What does that mean? Basically, the Rolls-Royce dividend looks set to return – and grow – but only once the balance sheet is strong enough.

Balance sheet strength

A strong balance sheet makes sense for any business – and this has been proven at Rolls in recent years. When civil air travel demand collapsed during the pandemic, so did engine sales and servicing orders. That was a disaster for free cash flows at Rolls. They nose-dived from £873m in 2019 to negative £4.1bn the following year.

A sudden collapse in demand for civil aviation remains a risks, whether the reason is a pandemic, terrorist attack, volcanic dust, or some other event. That brings a risk of Rolls again heavily diluting existing shareholders, as it did during the pandemic.

Strengthening the balance sheet helps reduce that risk – but ties up cash that could otherwise fund the Rolls-Royce dividend.

The firm ended last year with £2bn in net debt. That was a sharp improvement from the prior year. But I see it as a long way from having a balance sheet with assured strength.

Future dividend prospects

On that basis I think there remains work to be done before the Rolls-Royce dividend comes back. I would be surprised to see it make a return this year, for example.

Longer term though, I do expect it to make a return as long as business results remain strong. Although the timeline is uncertain, management has now clearly set an expectation for the payout to make a comeback at some point.

That is not guaranteed, as is always the case with any dividend. But if the business continues to perform well financially, I now think the Rolls-Royce dividend could return over the next few years.

On its own though, that is not enough for me to buy the shares. After all, the risk of a sudden collapse in demand remains.

After rising 180% in the past year, I do not think the Rolls-Royce share price offers me a comfortable margin of safety. So, dividend or not, I have no plans to buy.

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.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. 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.

More on Investing Articles

Investing Articles

1 FTSE dividend stock I’d put 100% of my money into for passive income!

If I could invest in just one stock to generate a regular passive income stream, I'd choose this FTSE 100…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

Forecasts are down, but I see a bright future for FTSE 100 dividend stocks

Cash forecasts for UK dividend stocks are falling... time to panic! Actually, no. I reckon the future has never looked…

Read more »

Young female analyst working at her desk in the office
Investing Articles

Down 13% in April, AIM stock YouGov now looks like a top-notch bargain

YouGov is an AIM stock that has fallen into potential bargain territory. Its vast quantity of data sets it up…

Read more »

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Beating the S&P 500? I’d buy this FTSE 250 stock for my Stocks and Shares ISA

Beating the S&P 500's tricky, but Paul Summers is optimistic on this FTSE 250 stock's ability to deliver based on…

Read more »

Passive and Active: text from letters of the wooden alphabet on a green chalk board
Investing Articles

2 spectacular passive income stocks I’d feel confident going all in on

While it's true that diversification is key when it comes to safe and reliable investing, these two passive income stocks…

Read more »

Investing Articles

The easyJet share price is taking off. I think it could soar!

The easyJet share price is having a very good day. Paul Summers takes a look at the latest trading update…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

9 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

As the Rentokil share price dips on Q1 news, I ask if it’s time to buy

The Rentokil Initial share price has disappointed investors in the past 12 months. Could this be the year we get…

Read more »