Rolls-Royce (LSE: RR) shares have had a lot of attention lately, but the stock has been falling. So if it has taken a hit, is now a buying opportunity? I think so and I’d buy Rolls-Royce shares in my portfolio.
Civil Aerospace
I can’t deny that Roll-Royce’s main business, the Civil Aerospace division has been severely hit by the coronavirus pandemic. I think what makes it worse is that revenue from this business accounts for over 50% of the company’s total earnings.
But what does the Civil Aerospace division do? In a nutshell, it manufactures and services engines for the airline industry. So it’s no surprise that it has been hit by the pandemic. Global restrictions have meant little travel travel, thereby having a knock-on effect on the need for Rolls-Royce’s services.
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Now that there’s a mass vaccination programme under way, I expect air travel to start recovering slowly. I reckon there’s pent-up demand for people to holiday abroad. This in turn should start having a positive impact on Rolls-Royce shares.
In its December trading update, Rolls-Royce reported that the Civil Aerospace business is gradually recovering. The number of large engine flying hours at the time was 42% of 2019’s level.
While no one can predict the shape and timing of the recovery in air traffic, Rolls-Royce expects travel to pick up in the second half of 2021. By this time, I’d expect vaccines to have been rolled out a significant portion of the UK and global population
Liquidity
During the coronavirus crisis, Rolls-Royce improved its liquidity position. It raised money from a rights issue, and secured additional loans, as well as drawing on its existing cash reserves.
Rolls-Royce took further measures by implementing cost-cutting measures and disposing of certain assets. To me, these steps have not only made the firm leaner but have also strengthened the balance sheet.
According to its latest update, Rolls-Royce has access to £9bn in liquidity. It forecasts £2bn in cash outflow for 2021. For now, I reckon it can weather the storm and I’d buy the shares.
Risks
I think the biggest risk right now facing Rolls-Royce share is that no one knows how long this pandemic and restrictions will persist for. If this crisis drags on, this may place a strain on the business and liquidity reserves.
Furthermore, if air travel doesn’t pick up in the second half of 2021 then Rolls-Royce may have to raise further capital. Another round of financing may not be well received by investors and could impact the share price.
Defence business
Clearly, I don’t think all is lost with Roll-Royce shares. I believe investors have become fixated on the company’s Civil Aerospace business and have forgotten that it has other divisions as well. In fact, I’d like to highlight its Defence business, which accounts for 20% of earnings.
What I like about Rolls-Royce shares is that the defence business throughout the pandemic has been resilient. The company has defence contracts with the UK and US governments. It also has a strong order book and 2021 forecast sales are well covered.
For now, I’m happy with the stable revenue visibility from this division.
