This has had a devasting effect on the global aviation industry and Rolls-Royce, which is one of the largest suppliers of aircraft engines in the world
But with the global economy beginning to show signs of life again, could now be the time to buy the Rolls-Royce share price?
Rolls-Royce share price on offer?
Even though it’s one of the largest suppliers of jets for aircraft in the world, Rolls-Royce doesn’t make much money on the sale of each engine.
Instead, the company relies on lucrative after-sales service contracts. These guarantee a steady cash flow in the years after each engine is sold. However, many of these contracts are also tied to the number of hours flown. In other words, Rolls-Royce doesn’t get paid if these engines don’t fly.
As demand for air travel has collapsed over the past few months, income has dried up. This has devastated the firm’s bottom and the Rolls-Royce share price. While the company also has significant defence and marine operations, management was relying on the cash flows from engine and maintenance contracts to help grow the business over the next few years.
For example, management was targeting free cash flow of £1bn per annum from operations at the beginning of this decade. This target has now been scrapped.
To try and stem the bleeding, Rolls is planning 9,000 job cuts. There have also been reports the company has asked the government for help. These actions may help the company weather the storm.
But, at this point, it’s difficult to tell what the future holds for this engineering champion.
Margin of safety
Airlines around the world are starting to reopen operations again, which is good news for the Rolls-Royce share price. But, at this stage, it’s also difficult to tell if the company will ever return to its former glory.
Forecasts suggest demand for air travel won’t return to 2019 levels until at least 2023. That may mean Rolls-Royce faces a couple of years of uncertainty.
However, with the stock down 44% since the beginning of the year, it looks as if the shares offer a wide margin of safety for investors. As such, it may be worth buying a share of this global engineering champion as part of a well-diversified portfolio.
While the business may be facing several years of uncertainty, it’s still one of the world’s leading aerospace and defence companies. This is unlikely to change any time soon. What’s more, research shows that buying stocks with a wide margin of safety can generate substantial returns for investors, even if the companies have uncertain futures.
With that being the case, the Rolls-Royce share price could be a great way to play the global economic recovery.
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Rupert Hargreaves has no position 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.