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Rolls-Royce: here’s what I think will happen next after the rights issue

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In October, Rolls-Royce (LSE: RR) shareholders overwhelmingly approved a rights issue that improved the company’s liquidity substantially. 

Although the rights issue added only £2bn directly, shareholder approval of the capital raise also unlocked additional debt options that increased liquidity by another £3bn. Some £2bn of that is from a bond issuance earlier in October and the rest from a two-year bank loan. 

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With the total £5bn in extra liquidity, many analysts now think Roll-Royce has enough money to make it through the pandemic. 

But now that the rights offering is approved, what comes next? Here’s what I think might happen. 

Less volatility?

Due to the stock offering, I don’t believe Rolls-Royce will see the big lurches up or down that it has seen of late. Its upside potential is reduced, I feel, as there are simply a lot more shares after the rights issue.

In the rights issue, RR shareholders were entitled to buy 10 new shares at 32p-per-share for every three they owned. If every investor took the company up on the offer, its stock float would have more than quadrupled. So if RR recovers to its pre-pandemic earnings level, its profits will be divided among more shares and earnings per share will likely be lower. 

That being said, I think the airplane engine maker’s prospects have improved overall. As a result of the rights issue, many analysts think RR has a higher probability of making it out of the pandemic. 

I also don’t think the worst case scenario is very likely given the recent Pfizer Covid-19 vaccine candidate news, and the Moderna news too.

The interim vaccine data is better than many had expected. In the worst-case scenario, RR would take a lot longer to recover than expected, but a vaccine could transform its fortunes.

Earnings recovery: still some way off?

The shares have surged recently due to the vaccine news. But I think Rolls-Royce could take some time to recover fundamentally. 

Long-haul flights depend on what’s happening in multiple nations to recover. And many analysts think the category could bounce back later than other segments of air travel. Some analysts think it could be 2025 before the wide body engine market recovers.

With that said, I still think there’s potential for a surprise in terms of the speed to normalisation. 

The fast rebound of travel in China also gives me hope that travel outside the country could come back faster than expected. That is, if an effective vaccine is distributed sooner rather than later. 

Given the economic destruction Covid-19 has caused, governments around the world have spent a lot of money fighting it. And once a vaccine is approved in the West, governments globally will be focused on distributing it as fast as they can. 

Effective distribution is key to any return to normality and also key to a Rolls-Royce recovery, I feel. 

Going forward, I would keep a close eye on RR. If there are meaningful dips, I would consider buying the stock and holding for the long term.

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Jay Yao 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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