Airlines are starting to fly again. The prime minister has promised us quarantine-free air corridors so that we can enjoy European holidays this summer. The Rolls-Royce (LSE: RR) share price is now up by around 20% since mid-May. Is it time to start buying this aero engine maker?
I reckon Rolls-Royce shares offer decent value for long-term investors. But, as I’ll explain, it could be a bumpy ride.
Can Rolls-Royce repeat 200% gains?
The last time the Rolls-Royce share price was under 300p was in 2009, during the depths of the financial crisis. Over the three years that followed, the shares rose by nearly 200%.
It’s tempting to suggest the same might happen over the next few years, but I’m not convinced. In 2009, the world’s airlines were entering a massive period of growth. Passenger numbers have exploded over the last decade, with many new routes added.
But I don’t expect this growth to be repeated over the next decade. Airlines such as IAG and easyJet were already slowing their growth rate before Covid-19 struck. They’re now planning big job cuts and shrinking their fleets.
Figures from the airline industry association IATA suggest that passenger numbers won’t return to 2019 levels until 2023.
Look beyond airlines
Right now, the outlook for Rolls-Royce’s civil aerospace division is very uncertain indeed. Fortunately, Rolls has several other valuable businesses. The one that interests me most in the current environment is the defence business, which makes engines for military aircraft, helicopters, and nuclear submarines.
Last year, the defence business generated an underlying operating profit of £415m on sales of £3,546m. New orders totalled £5.3bn — a record-breaking performance. The company says the outlook for 2020 is unchanged, suggesting a stable result.
With the Rolls-Royce share price hovering around 300p, the market-cap for the entire group is just £5.5bn. In my opinion, the value of the defence business alone should cover most of that valuation.
In my view, anyone buying the shares today is getting Rolls’ civil aerospace, marine, and research businesses thrown in at rock-bottom prices. Although these operations are facing cyclical downturns, I can’t see any reason why they won’t recover.
Rolls-Royce share price: the right time to buy?
Will Rolls need a bailout? The group does great engineering, but its financial history is mixed. Fortunately, I don’t think shareholders need to be too worried this time.
When the coronavirus crisis started to hit airlines, CEO Warren East acted quickly to slash spending. In May, East said cost-saving measures had freed up an extra £1bn of cash this year. In total, Rolls has access to more than £6.5bn of cash and unused debt facilities. I think that should be enough.
Indeed, I believe the firm’s stock offers decent value at current levels. Rolls has a big market share in several key sectors, each of which I think will gradually recover. In the meantime, the defence business has a stable outlook and a strong order book.
However, if you buy Rolls-Royce shares, I think you’ll need to be patient. The timing of the group’s recovery looks uncertain to me, and could be quite slow.
