The Rolls-Royce (LSE:RR) share price slumped from 200p to around 100p during the coronavirus market crash in March 2020. The price of the blue-chip stock continued to fall all the way to 35p in October 2020, but has since recovered to around 100p at the time of writing.
Rolls-Royce did suffer during the pandemic as it is heavily exposed to the airline sector. It does not make much money on initial engine sales. But, it does make money from monitoring and servicing them. The more time planes spend flying, the better for Rolls-Royce. Since planes were grounded during the pandemic, it stands to reason that Rolls-Royce would take a financial hit. The company booked a net loss of £3.2bn for 2020 and did not pay a dividend.
But, if the pandemic looks to be ending, and planes are flying, Rolls-Royce, and its share price, should be fine, right? I don’t think so. I think a lot of the commentary on Rolls-Royce is too short-sighted. Yes, the pandemic might have been the straw that broke the camel’s back, but Rolls-Royce and its shareholders have been struggling for years.
Rolls-Royce has been struggling for years
I think it would be a mistake to assume that once the pandemic is over, the Rolls-Royce share price will recover. Since the high of near 400p in January 2014, the Rolls-Royce share price has headed lower, albeit with periods of respite.
When I look at the company’s financial performance, its multi-year stock price slide is not surprising. Gross margins have contracted every year since 2015 and even turned negative in 2020. Operating margins have been negative since 2018. The company made a profit in 2015 and 2017 but posted losses in 2016, 2018, 2019, and 2020.
|Net Income Margin||1%||(27)%||23%||(15)%||(8)%||(26.80)%|
Rolls-Royce has raised billions in equity and debt to shore up its balance sheet during the pandemic. This will dilute shareholder returns for years to come. There are also current and future restructuring charges for shareholders to contend with, as Rolls-Royce tries to turn things around, perhaps balanced by cash from asset and business sales.
Rolls-Royce share price
Rolls-Royce’s turnaround requires air travel to get back to normal as it gets about half its revenues from its commercial aviation business. Optimistic projections have passengers taking to the skies as normal as early as this year. Others think 2035. Whatever the case, Rolls-Royce’s Trent family engines power wide-body aircraft. Narrow-body aircraft that make shorter flights seem to be where the recovery will happen fastest.
Returning Rolls-Royce to its pre-pandemic state is not something I would be relishing as a shareholder. It needs to do more than that. Rolls-Royce is part of the consortium that won a £250m contract to develop the UK’s next-generation combat aircraft called Tempest. The company is leading a consortium hoping to build small modular nuclear reactors, which the current UK prime minister backs as part of his 10-point plan for a Green Industrial Revolution. Rolls-Royce’s UltraFan engines will power narrow-body aircraft, diversifying it away from wide-body planes.
But those new engines won’t be in service until 2030, and those reactors and the Tempest aircraft could take even longer to enter service. I see Roll-Royce shares as a speculative recovery play at this stage, which could take years to pay off. I think there are better shares for me to buy than Rolls-Royce, even at 100p.
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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.