The Rolls-Royce (LSE:RR.) share price has tumbled by almost 40% in the last 12 months. Yet over the past couple of weeks, the stock has actually surged by over 30% on the back of recent trading updates.
What’s going on? Has the leading engineering firm’s long-awaited recovery finally begun? And should investors consider this business for their portfolios today?
What’s behind the share price momentum?
With a substantial chunk of its revenue stream originating from the civil aerospace sector, it’s not surprising that Covid-19 had a massive impact on this business. And while packed airports suggest the effects of the pandemic have passed, the reality is a little murkier.
While short-haul flights are close to pre-pandemic levels, the same can’t be said for long-haul ones. And sadly, it’s the latter that Rolls-Royce serves. According to its latest trading statement, total flying hours for its Trent engine remain depressed at 62% of 2019 levels.
That’s much lower than management’s 2021 target of 80%. And while Covid restrictions in China are largely to blame, it begs the question as to why the Rolls-Royce share price has suddenly started surging?
While flying hours may be lower than expected, they’re still 36% higher than a year ago. At the same time, its Defence division is seeing increased demand, while its Power Systems segment secured new contracts, including a deal to supply 500 engines for UK armoured vehicles.
The group’s cash outflow has finally been sealed tight after a radical restructuring of the business. This saw the €1.6bn (£1.4bn) sale of its ITP Aero business and the unfortunate termination of 9,000 employees.
However, the sale proceeds, cost savings, and improved revenue streams mean Roll-Royce is no longer haemorrhaging cash. Needless to say, that’s an excellent sign of recovery progress.
With almost all the proceeds of the ITP Aero sale used to pay down debts, the company has some breathing space. The next £500m loan maturity isn’t due until 2024, giving management more time to bolster its free cash flow.
However, the firm still has around £4bn of debt outstanding. And while the interest rates on its loans are fixed, the cost of servicing these debt obligations remains high. Suppose operating cash flow is unable to grow further within the next two years. In that case, more disposals or employee dismissals may be on the horizon.
Meanwhile, management has been coughing up to raise inventory levels, especially in its Power Systems division. This is to combat global supply chain disruptions, ensuring customer contracts can be fulfilled on time. Sadly, price inflation on doing so is also affecting margins. At least in the short term.
So, with all that said, is the Rolls-Royce share price on track to make a full recovery in 2023?
The shares will likely continue to climb from here if the group continues to make solid operational and financial progress. However, the complete recovery of this business is primarily tied to the long-haul travel market. And since analyst forecasts indicate the latter won’t fully recover until 2024, it seems logical that Rolls-Royce shares will do the same.
Nevertheless, a turnaround seems entirely plausible, potentially rewarding patient investors.
Zaven Boyrazian 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.
Motley Fool UK 2022