A question on engineering analysts’ minds last month was whether Rolls-Royce Holdings PLC (LSE:RR.) shares had hit bottom after dipping to a twelve-month low
Some are not convinced, though the shares have seen a modest bounce recently.
JP Morgan reiterated its guidance for the British aero-engine maker and engineering business as ‘underweight’.
The investment bank’s analysts said that, based on the company’s guidance last week, a “vast majority” of its free cash flow this year “will come from customer advances as opposed to profit”.
This pessimistic outlook flew in the face of the broker’s general advice to investors, which was to buy defence stocks, ahead of the EU Council summit.
With demand for military resources rising since the Ukraine war and UK Prime Minister Boris Johnson’s renewed commitment to nuclear energy, Rolls-Royce's businesses—Civil Aerospace, Defence, Power Systems and Electrical—should in theory be well-positioned but the share price slump suggests otherwise.
Rolls-Royce's share price has been on a turbulent ride ever since Covid struck in 2020.
Before then, the last time that the company’s shares fell below 100p per share was in 2009.
Its share price today, 88.5p, is above its 2020 nadir of 61.8p, but that’s not much to cheer about for investors.
Covid still hanging around
A major chunk of Rolls-Royce's business is in the engineering and aerospace sector and while it has embraced what it refers to as the third era of aviation, identifying the electrification of flight as one of the latest challenges facing the sector, analysts are less than enthusiastic.
One shaft of light during Covid was the strength of freight traffic, but even this has come under pressure with China shutting down its main business hub due to a new outbreak there.
A recovery in transatlantic traffic to and from China was one of the predicted planks in a bounce-back by the major flagship airlines and their suppliers, such as Rolls-Royce.
Inflation in parts and labour is another issue though Rolls said in a trading update on 12 May: “Our long-term sourcing agreements and hedging policies designed to limit volatility in raw material inflation, give some near-term protection and we have increased inventory levels to help mitigate the impact.”
It added: “In Civil Aerospace, large engine long term service agreement (LTSA) flying hours for the first four months of 2022 were 42% higher than the prior-year period,” though that was a depressed comparison due to Covid.
“Passenger demand is recovering on routes where travel restrictions have been lifted, such as in Europe and the Americas, but additional COVID-19 restrictions have resulted in fewer flights in China where the situation is still evolving,”
Divestiture plans ongoing
Part of its long-term financial plan also involves divestiture.
The company said: “We are progressing well with our programme of disposals and are confident in achieving the commitment to generate around £2bn in total proceeds once the sale of ITP Aero completes, which is expected to be in the first half of this year, subject to regulatory approvals.
“The proceeds from the programme of disposals will be used to repay debt.”
In its New Markets business, it has completed flight testing of a hybrid electric demonstrator aircraft powered by a parallel hybrid propulsion system, but this is something for the long term
Rolls-Royce chief executive Warren East said: “As a result of the actions we have taken, we have made significant progress on the path to recovery from the impact of COVID-19 and are emerging as a better balanced and more resilient business with a sustainable future, focused on the long-term business opportunities presented by the global energy transition.”
It was upbeat enough given the background but once again the phrase long-term featured in a Rolls-Royce update and for what is arguably Britain’s flagship company, perhaps, for now, the market has got it right.