FTSE 100 engine manufacturer Rolls-Royce Holdings (LSE:RR) is having a tough year. The coronavirus pandemic brought airlines screaming to a halt, putting parts and repairs on hold. This immediately affected Rolls-Royce, creating unparalleled challenges for the company. The Rolls-Royce share price is down 13% in the past month and 65% year-to-date. Unfortunately, a further slide seems likely.
Power-by-the-Hour
The Rolls-Royce income model is unusual. Power-by-the-Hour, a Rolls-Royce trademark, was conceived in 1962. It means the company sells its engines at a loss, making its money from aftercare service. This guarantees the buyer a quality service and engines that perform well, while the firm enjoys a steady income based on hours flown. It is a model that worked well for over 50 years, but the pandemic has seen it come crashing to a halt. The business is now haemorrhaging money as the costs to continue far outweigh the money flowing in. Illustrating why the Rolls-Royce share price is suffering so badly.
£1.5bn rights issue
Financial analysts examining the company have warned that it could need to raise a minimum of £6bn to get through the crisis. Ratings agency Moody’s downgraded the Rolls-Royce credit rating to Junk at the end of July, which makes it much more difficult to borrow sizeable sums of money. As a business that requires large amounts of cash to operate, it is resorting to a rights issue to shore up its funds.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
A rights issue is basically a share placing, diluting the existing shares, by introducing a batch of new ones. These are offered to existing shareholders, giving them the opportunity to own more of the company at a lower price. In its upcoming rights issue, scheduled for September, it hopes to raise £1.5bn to improve its balance sheet and help recovery from the pandemic-induced aviation crash.
It is also considering putting its Spanish turbines manufacturer, ITP Aero, up for sale. From this, it would hope to raise around £1bn. Prior to this it already cut 9,000 jobs and cancelled its dividend, both of which further hammered the RR share price.
Rolls-Royce share price woes
Although the airline business is struggling, Rolls-Royce is a world-leader in other areas of manufacture. I like that it is heavily involved in Artificial Intelligence, which is a business for the modern age. If it can get its financial worries under control, then I think it still has a lot going for it.
Geopolitical tensions, on heightened alert for years, now appear to be escalating. This benefits the Rolls-Royce defence division, which continues to receive government orders. There is clearly a lot of concern surrounding how it can get back on track, but I will be very surprised if this company goes under.
This may make the shares a tempting bargain at current prices. However, with the rights issue ahead, I imagine they have further to fall. I would wait until later in the year before considering buying any shares.
