If you’d read my previous post you’d know I was bullish on the shares prior to the FY results from a few weeks back. I knew I should have bought more! Well, actually I didn’t and seeing as they’re already my largest holding it seemed like a rational risk to simply hold and see what happened. I was confident they wouldn’t go down in value but since my last post the RR shares have risen by around 37% and now take up an even larger percentage of my portfolio! Nice problem to have I guess.
Anyway, now that the shares have stabilised, I think it’s a good time to properly evaluate Rolls-Royce and see if they have further to climb or have they reached their destination? 🙄
In a pre-COVID-19 world
Once upon a time in a world that seems much like today… Rolls-Royce were a larger company with far fewer shares in circulation, less debt, paying out a mediocre dividend and were struggling with durability issues on their flagship engines, the Trent family including the Trent 1000 and Trent 900, which were the engines on the Boeing 787 and Airbus A380 respectively. Things seemed problematic even then but if we compare the company value then with the company value today it should give us an idea of target share prices perhaps?
The shares were priced between £8.17 and £9.28 at the time the Trent engine durability issues were being uncovered (March 2018), so the market cap of Rolls-Royce back then was between £15.2 billion and £17.3 billion. This compares to the current market cap of £12.5 billion, so up to £4.8 billion less. If only it were that simple, in order to stay afloat during the pandemic Rolls had to make some disposals. They sold ITP to Bain Capital Private Equity in September 2022 for €1.8bn including a dividend payment (approx £1.6bn). They also sold off Bergen Engines to Langly Holdings, gaining €107mn (£95mn) in January 2021. In addition to this Rolls-Royce sold a stake in AirTanker Holdings Ltd to Equintix Investment Management Ltd for cash proceeds of £189mn in September 2021. Additionally, they shifted their civil nuclear instrumentation & control (I&C) business to Framatome in November 2021, can’t seem to locate a value for this one though.
Total (known figures) disposals come in at just shy of £1.9bn, so let’s assume the £2bn target Warren East set for himself was met. The proceeds of these sales were used to pay down debt. Speaking of debt, the debt pile announced at the FY 2022 stood in at £5.96bn, the debt at the same time in 2018 was £4.66bn. To be fair, this was already rising due to the Trent engine issues but was £1.3bn lower either way.
During the Pandemic Rolls-Royce announced a rights issue with an aim to raise a little over £2bn, this increased the shares in circulation from 1.93bn to 8.36bn. Putting it simply if you owned 1000 RR shares at the time of the rights issue then you had the option to purchase 3333 new shares at 32p each.
Actually, let’s produce a quick and easily digestible comparison table…
Rolls- Royce historical comparison
| 2022 (£m) | 2018 (£m) | |
| Cash | 2,383 | 4,949 |
| Revenue | 13,520 | 15,729 |
| Net cash flow | -34 | 2,019 |
| Net income | 837 | -1161 |
| Debt | 5,955 | 4,622 |
| Total assets | 29,450 | 31,857 |
| Total liabilities | 35,500 | 32,931 |
| Total voting rights (shares) | 8,367,596,989 | 1,859,848,150 |
| Share price | 150p | 817p – 928p (Mar 2018) |
| Market cap | £12.5bn | £15.2bn – £17.3bn |
Looking at the above, RR clearly has less cash, revenue and assets with more debt. If we were to take the disposals (ITP etc) and the net difference in debt and cash from 2022 and 2018 we come in at between £11.9bn and a smidge over £14bn, meaning a per share price of between 143p and 168p with today’s total number of shares in circulation – pretty much bang on with current share prices.
Rolls-Royce was also paying a small dividend back in 2018, about 12p so really not much, that would have been less than a 1.5% yield.
A lot’s changed, do they hold any value?
The above parity between Pre-COVID and Trent issues and present-day is surprising given that so much has changed in the world. Rolls-Royce is currently targeting the reduction of debt, lowering its cost base and (at least right now) targeting lots of markets with products in its arsenal, think SMR, eVTOL and next-generation fighter aircraft. Some of these could change over the next few months as Tufan Erginbilgic makes decisions as essentially he will be looking to increase product profitability across the board, this has been a long-standing issue at RR which has suppressed the returns for shareholders for as long as I can remember.
The core RR businesses are in a prime position. The civil market is back to Pre-COVID, OK the numbers aren’t quite there yet but the trend is and this market is undoubtedly going to grow. The Defence business is highly likely to see an uptick in demand thanks not only to the war in Europe brought on by Russia miscalculating the abilities of Ukraine but also by what could potentially (if not already) become an arms technology advancement race with China. Put simply the Western world has been awakened to not only the requirement for much more military hardware to be available at short notice but also the need for this hardware to be more advanced than the opposition.
On top of this the need for greener power generation is overwhelming but just a mix of solar, wind and tidal can’t guarantee reliability, yes battery storage will help but still, no guarantee. That’s where nuclear could become the backbone of future energy security and Rolls-Royce is pushing here also.
Are they still worth buying?
All of these RR markets have a very high cost of entry so there is no doubt that Rolls-Royce are in a good spot. If they can reduce the debt, increase profitability and actually generate an investor return like Tufan (and all the shareholders want) then it’s feasible (likely in fact) that the share price will rise further. At present the RR P/E is standing at around 15, this is not unreasonable albeit perhaps slightly pricing in some growth but there is no reason not to buy in at this level.
In the FY statement, the group posted free cash flow of £500m this is up around £2bn on the previous year, it should be noted that this was driven mainly by a 35% uptick in large engine flying hours, as noted above this will have surely increased since. Also, Although Defence revenues were up only slightly the more important metric for me is that order intake has more than doubled, again this is likely to increase further given the global turmoil we’re witnessing. I guess a key concern here will be if the supply chain can keep up with demand but you have to assume potentially extending lead times and costs are being taken into account when accepting these orders, this could have an impact on actually receiving the payment post-delivery and it’s not cheap to produce these world-class products!
I’m back to where I started, I really can’t see any reason not to buy more (even with the 37% increase since my last post) but Rolls-Royce already makes up more than a third of my entire portfolio. I certainly won’t be selling so I need to buy more of other companies to reduce the RR colour of my pie chart!