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Will the Rolls-Royce rights issue secure its future?

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The aviation industry is not doing well. You don’t need me to tell you this. Naturally, those firms dependent on the industry are suffering too. Engine maker Rolls-Royce (LSE: RR) announced its need last week to raise more finance. But will the rights issue be enough to help its struggling shares?

The Rolls-Royce rights issue

Last week the company said it would be raising £2bn and drawing on £3bn in government support. The rights issue offers shareholders 10 shares at 32p each for every three shares they own. This amounts to a 41% discount on the theoretical price after the issue.

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The share price was hit initially on the news, down about 11% on the day. As it stands, the stock has managed to claw back these losses however, and is up about 20% from its recent low.

The Rolls-Royce rights issue is not taken in isolation. The company said in addition to the £2bn already agreed with the UK Export Finance agency, it would seek an additional £1bn loan guarantee.

Rolls-Royce needs the cash desperately. On the back of the Covid crisis, the company will suffer a cash outflow of about £4bn this year. Its net debt has rocketed, expected to reach £3.5bn by the end of 2020.

What is worse, around £3.2bn of its debt is due next year. Rolls-Royce is going to need to refinance in order to pay off this debt. Having seen its credit rating reduced to junk status, this is going to be costly.

Long-term problems

The rights issue and loan guarantees from the government may not be enough to secure its future. Naturally, much will depend on the aviation industry and its recovery (or not) from the coronavirus pandemic.

Rolls-Royce could be hit on a few fronts. The most obvious, of course, is lack of air travel. It makes its money not just from selling engines, but from maintaining and servicing them as well. Fewer planes flying mean Rolls-Royce is making less money from both these avenues.

Naturally, this problem will be exacerbated by any airlines going bust over the next year. A recession, meanwhile, will mean fewer people fly, even if coronavirus is no longer an issue. All told, the aviation industry does not look to be in a good position.

The refinancing could also be a long-term problem. Rolls-Royce is going to be in a lot of debt. At the moment, there are no real signs of a massive cash influx coming from growth or sales.

The credit ratings downgrade and the industry’s sour-looking prospects are going to make this debt expensive for the company. The rights issue may help get the company through the next six months, but what about the six months after that?

Given the level of its share price, any recovery may offer us a bargain right now. Personally though, I think there is a lot more risk for the company’s future than any potential upside. I just don’t think the Rolls-Royce rights issue is enough to guarantee anything good.

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Karl 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.

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