Aeronautical engineer Rolls-Royce (LSE: RR) issued its interim results today. They cover the first half of the financial year. Why does that matter for the Rolls-Royce share price? In short, the City sees the Rolls-Royce results an up-to-date indicator of business health, with clues to how the business may perform in the future. Here I explain what that might mean for the share price.
The big issue: free cash flow
I previously flagged that the main thing I would be looking for in today’s Rolls-Royce results was any update on its expectation of turning free cash flow positive in the current half. That matters because liquidity concerns dogged the shares last year. Issuing new shares to boost liquidity was one reason Rolls-Royce shares fell last year, as it diluted existing shareholders. That is an ongoing risk with a capital intensive business such as Rolls-Royce.
Being free cash flow positive matters because it means that there is more hard cash coming in the door than going out. That provides a stronger liquidity cushion for a company.
In the results, Rolls-Royce again reiterated its target to turn free cash flow positive this half. It said explicitly, “We continue to expect to turn free cash flow positive sometime during the second half of this year”.
Negative free cash flow in the past six months stood at £1.2bn, which is a sharp drop from last year. So the company expects negative cash flow to keep falling until it reverts to being positive. I think management credibility now depends on delivering this target as it has stated it so often. I think turning free cash flow positive could help boost the Rolls-Royce share price.
Rolls-Royce results show a return to profit
While cash flow is critical, the accounting concept of profit also matters in assessing a company’s prospects. In the half, Rolls-Royce recorded a profit of £393m, versus a huge loss of £5.4bn in the equivalent period last year.
That equates to earnings per share of 4.7p. If that is maintained in the second half, it suggests that the company is currently trading at a prospective price-to-earnings ratio of around 11 or 12. That is fairly low so, following the Rolls-Royce results, I see upside potential for the shares. However, the valuation may reflect ongoing risks. For example, while aviation demand is returning, it is doing so in fits and starts. That means that the first half performance won’t necessarily be repeated in the following six months, for example if new travel restrictions are put in place.
No dividend in the Rolls-Royce results
The company did not announce any interim dividend. That is not surprising to me, as the company is still in a recovery phase. It makes sense to keep as much money as possible in the business while it rebuilds.
Even if the company wanted to pay a dividend, it wouldn’t be allowed. A loan it drew down during the first half precludes it from paying any dividends until 2023.
Rolls-Royce results summary
There was much positive news in the results, including a recovery in revenues and profits. I think the repeated target of returning to free cash flow in the current half is significant. I expect the results to be well-received, which could help boost the Rolls-Royce share price.
