The whirlwind turnaround performance in Rolls-Royce (LSE:RR) shares over the past year has been nothing short of incredible. The stock is up 192% over this period, buoyed by stronger earnings and better cash flow. As a result, income investors are starting to sniff around for the potential of dividends. Here’s what I think the future looks like from that angle.
How we got to this situation
Rolls-Royce might not be currently paying out dividends, but it has a history of doing so. In fact, if I was writing this at the start of 2020, I’d be proudly stating that the firm had continuously paid out income for the past two decades.
That all changed with the pandemic, with the shutdown in air traffic being a disaster for the company. The lack of need for new engines or even servicing existing ones meant that the Civil Aerospace division took a heavy knock.
The ensuing losses and ballooning debt levels meant the business cut the dividend to zero and has held it there ever since. In fact, for much of the past few years, it didn’t make any sense to even write about the potential of an optimistic dividend forecast.
However, thanks to the pandemic woes now being behind us, business is back on track. For 2023, the firm posted a profit before tax of £2.4bn, the first since 2020. With the outlook now much more positive, we can finally start to think about shareholder payments returning.
Unlikely to pay this year
I don’t think that any dividends will be paid out in 2024. To begin with, the job of rebuilding the firm is ongoing. CEO Tufan Erginbilgic is still heavily focused on cost-cutting and driving efficiencies. Therefore, it makes little sense for him to start paying out income if the mandate is still to try and reduce expenses.
Further, it’s likely that the company will wait until its rating from financial agencies improves. For example, one of the main agencies (Fitch) upgraded the company to BB+ late last year. It needs to be widely upgraded further to BBB in order to be deemed investment grade. This means that it can more easily raise debt and do so at cheaper rates.
Until the business can show that it’s financially sound again, I struggle to see management being willing to start dividend payments.
The change is coming
I think the picture changes for next year (2025). On the basis of another strong financial year, along with a better rating, I believe that a dividend will be announced alongside the 2024 full-year results.
In the three years before 2020, the full-year final dividend per share was 7.1p. I think that this could be a reasonable benchmark figure to resume a payment at. Based on the current share price, this would give a dividend yield of 1.69%.
I know that this isn’t going to set the world on fire. Income investors might think that the risk isn’t worth it and look elsewhere. I believe that even though the initial dividend might not be amazing, it signals that the business is doing well. From there, higher dividend payment should be noted.
Although I’m not ready to buy the stock yet, it’s on my radar as an income option to review later in the year.
