2020 was a tough year for the Rolls-Royce (LSE:RR) share price. The pandemic disrupted many industries, but one of the most heavily impacted was aerospace. Unfortunately for Rolls-Royce, that’s the sector in which it generates most of its revenue.
However, now that multiple vaccines are being rolled out, is the Rolls-Royce share price a bargain? Let’s take a closer look.
What caused the Rolls-Royce share price dive?
Just over 50% of the stock’s revenue is generated by manufacturing and servicing aircraft engines. With Covid-19 keeping most flights grounded, demand for this business segment hasn’t been very high.
As such, Rolls-Royce has suffered significant business loss, and the firm expects to make a net loss of £2.6bn by the end of 2020.
Following multiple vaccines becoming available, the aerospace industry has begun recovering, and with it, the Rolls-Royce share price. However, investor expectations should be kept in check as the sector’s rate of recovery will be very slow. So slow in fact that current forecasts indicate that the industry won’t return to pre-Covid operational levels until 2024.
Some worrying financials
If Covid-19 was the only problem facing the business, then at today’s share price, Rolls-Royce would look cheap in my eyes. Unfortunately, the company has been struggling for many years, long before the pandemic began.
Looking at the firm’s net income over the past six years, it has only been profitable for two of them, and not by a large margin.
What’s even more concerning is the state of the balance sheet, more specifically the level of debt. Due to the low operational performance throughout 2020, the management team borrowed more money to keep the business afloat. Today, the firm’s total debt stands at £8.7bn, which is almost the same as the current £9bn market capitalisation of the entire company.
Even before the pandemic, the business was in quite a bit of trouble with its debt level. Combining its pre-Covid interest payments with capital leases results in a negative coverage ratio. In other words, Rolls-Royce isn’t generating enough income to pay its bills.
As such, the firm has been forced to issue new shares to raise capital or take on more debt. And it’s done both – a serious red flag in my eyes.
Rolls-Royce share price: a bargain or a value trap?
The Rolls-Royce share price may recover in the near term as investors regain confidence in the sector and as economies globally start to recover. However, in my opinion, the company has some serious financial problems that need resolving.
As such, it’s not a stock I would buy shares in, even at its current price. I think there are much better opportunities out there to grow my wealth, with a much lower level of risk.
Zaven Boyrazian does not own shares in Rolls-Royce Holdings. 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.