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The Rolls-Royce share price has crashed nearly 60% today: Here’s what I’d do about it

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The Rolls-Royce (LSE:RR) share price has slumped 65% this morning to 77p. Today’s share price crash is due to over 6bn new shares hitting the market. Since each share now represents a far smaller slice of ownership of Rolls-Royce, they are all worth less today compared to yesterday.

So, that explains today’s slump. But, why did all those shares hit the market today and why are they trading 93% below their December 2013 all-time high of 1,160p?

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Rolls-Royce share price slump

The first wave of the coronavirus caused air travel to all but disappear. Indeed, flights are now resuming, but passenger numbers, particularly on long-haul flights, are well below average. Most of the engines Rolls-Royce makes are fitted to the wide-body jets that fly the long haul routes.

Rolls-Royce typically makes a loss on the initial sale of the engines but earns money as the engines spend time in the air and from servicing them. When planes powered by the company’s engines don’t fly, then very little cash is collected. The COVID-19 crisis has led to a cash crunch at Rolls-Royce. To survive until air travel returns to something approaching normal, the company wants to raise £2bn of additional equity, which is why those new shares hit the market today. Also, £2bn of new debt is being raised with up to £2bn more depending on certain conditions being met. There is also a potential £2bn to be raised from selling assets.

There was not much Rolls-Royce could do about the pandemic. This degree of fundraising would not have been necessary, had it not happened. However, the company’s balance sheet was already in poor shape. Before the coronavirus hit, Rolls-Royce reported negative shareholders equity of £3.4bn and had liabilities totalling £32.2bn. And also, while the slump in air travel did cause an unexpected hit to the company’s revenues, its performance has been deteriorating long before anyone had heard of COVID-19. It’s no wonder the Rolls-Royce share price has been in a tailspin for some time.

Engine trouble

Revenue did climb from £13.7bn to £16.6bn from 2015 to 2019. However, gross profit fell over the same period, and Rolls-Royce reported operating losses in 2018 and 2019. Net income has been negative in three out of the last five financial years. 

  2015 2016 2017 2018 2019
Revenue 13,725 14,955 14,747 15,729 16,587
Gross Profit 3,266 3,048 2,422 1,198 942
Operating Income 1,501 41 1,151 (803) (713)
Net Income 83 (4,032) 3,382 (2,401) (1,315)

Source: Rolls-Royce (figures in £ million)

Taking a look at the company’s margins shows the same story: gross margins contracted from 24% to 6%, and operating margins turned negative between 2015 and 2019. The civil aerospace division accounts for over half of Rolls-Royce’s revenue. The problems with its Trent 1000 engine — apparent since early 2016 — are largely the cause of the company’s deteriorating performance.

  2015 2016 2017 2018 2019
Gross Margin 24% 20% 16% 8% 6%
Operating Margin 11% 0% 8% (5)% (4)%
Net Income Margin 1% (27)% 23% (15)% (8)%

Source: Rolls-Royce

The civil aerospace division is the one most affected by the coronavirus pandemic. And it will continue to struggle until long-haul air travel returns to normal. Some expect this will not be until 2024, although the company is more optimistic. It will be a long road back for Rolls-Royce and its share price, and there has to be concern about getting there at all. This stock does not look like a bargain to me, it’s just too risky, and I won’t buy shares in Rolls-Royce today.

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James J. McCombie 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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