After the Covid-19 pandemic spread across the globe in early 2020, airline traffic collapsed to a level unseen in the modern era. With governments closing their borders and imposing quarantines, airline miles flown dropped to near-zero. Even now, flight numbers are at roughly a quarter of their previous highs. This crash has devastated shares in Rolls-Royce Holdings (LSE: RR). What might lie ahead for Rolls-Royce shares?
Rolls-Royce shares plunge to earth
Less than 11 months ago — in a world before Covid-19 — Rolls-Royce shares were riding high. They hit a 52-week peak of 792p on 7 November, then slipped to end 2019 at 683.2p. Even as recently as 12 February, the stock closed at 699p. Then, as coronavirus worries spurred national lockdowns, Rolls-Royce went into a tailspin. Shares in the maker of engines and power systems collapsed to 251.6p by 3 April, driven down by relentless selling pressure.
As the spread of coronavirus slowed going into the summer, Rolls-Royce shares staged a partial comeback. By 8 June, there were trading within a whisker of £4, a decent bounce-back, yet still just over half of their November peak. Alas, with Covid-19 infections surging into the autumn, the Rolls-Royce share price crashed again, bottoming out at 100.8p on 2 October.
Rolls-Royce shares more than doubled this month
Since the start of this month, Rolls-Royce shares have been on a spectacular tear. On Friday, they closed at 243.7p, up a whopping 141.7% in just three weeks. This huge surge has propelled the esteemed engineering firm’s market value to £4.7bn. Nevertheless, Rolls-Royce stock has dived by two-thirds in the past 12 months, leaving the company a shadow of its former self.
Any investors astute or lucky enough to buy Rolls-Royce shares around the turn of this month will be sitting pretty on some extremely healthy profits. But will these last, given the existential crisis faced by the airline industry?
This FTSE 100 firm faces a tough future
One problem for the UK’s leading engineer is that it was already stumbling before the shock of Covid-19. Indeed, in the far better economic circumstances of 2018 and 2019, the business lost £2.947bn and £891m respectively. What’s more, most of its profits come from long-term maintenance contracts linked to hourly jet-engine usage. With airlines on their knees, Rolls-Royce will struggle for years to come, with normal conditions unlikely to return before 2024.
A warning from the bond market
With its earnings crushed and dividends vanished, it’s impossible to value Rolls-Royce shares using conventional metrics. However, one red flag for shareholders comes from the bond market — which takes no prisoners and bosses even the biggest businesses about!
On 14 October, Rolls-Royce issued £2bn of bonds, as part of a rescue fundraising that also included a rights issue for shareholders. The coupons (yearly interest rates) paid by these six/seven-year IOUs ranged from 4.625% to 5.75%. In 2017, the firm was able to borrow for six years at 0.875% a year. Today, similar high-yield (‘junk’) debt would be sold with an average coupon below 3.75%. Thus, ‘bond vigilantes’ — worried about Rolls-Royce’s future liquidity, solvency and survival — demanded steep returns to lend to the battered business.
In short, with airlines facing powerful headwinds, I can see Rolls-Royce again returning to shareholders (and/or bondholders) for more emergency bailouts. With the business set to survive, but not thrive, if I held Rolls-Royce shares, I’d sell them today. As a shareholder, I’d head for the emergency exits while the going was good!
