It’s been a good week for the Rolls-Royce (LSE:RR) share price. The stock shot up by double-digits yesterday, pushing its 12-month performance to just over 180%! So, what happened? And should I be considering this business for my portfolio? Let’s take a look.
The surging Rolls-Royce share price
The engineering giant has been working hard to recover from the impact of the pandemic, which decimated its aerospace revenue stream. To improve its financial health, management has been doing a bit of restructuring. And has begun selling off non-core assets to raise capital.
Yesterday it announced it had signed an agreement to dispose of its ITP Aero business for €1.7bn (£1.46bn) to a private equity firm. The deal is expected to be completed within the first half of 2022 and provides the company with a substantial amount of liquidity. Using the proceeds, the management team intends to pay down debts as part of its goal to revive the company’s investment-grade profile in the eyes of creditors. To me, this sounds like a good idea. And with a stronger balance sheet, Rolls-Royce will be able to access cheaper debt financing in the future should it need it.
However, this does not appear to be the primary catalyst behind yesterday’s surge. Beyond signing the disposal agreement, Roll-Royce has also secured a new $2.6bn (£1.9bn) government contract with the US Air Force. The firm will be supplying its F-130 engines for the fleet of B-52 Stratofortress bombers. This engine will then remain the standard power plant for these aircraft over the next 30 years, providing a new long-term income source.
Needless to say, this is excellent news for the business and provides a much-needed boost to its aerospace division. So, seeing the Rolls-Royce share price rise is hardly surprising. Having said that, I still have some concerns.
The risks that lie ahead
It’s pretty encouraging seeing capital flow again after the chaos in 2020 created by Covid-19. However, it’s not out of the woods yet. As of the end of June this year, Rolls-Royce had over £7.9bn of debt to contend with. While most of this doesn’t mature until 2024, relying on disposals to pay down loans over the long term is ultimately unsustainable.
Looking at its latest interim results, the company reported a £394m net profit. Considering it has been losing billions for the last three years, this is an encouraging sight. However, upon closer inspection, only £31m originated from operating activities, with the rest largely coming from one-time tax credits. Suppose the company cannot increase its operating profits in the near future. In that case, the recent improvements to its financial health may begin to reverse, as would the gains in the Rolls-Royce share price.
The bottom line
Overall, my opinion on the Rolls-Royce share and the underlying business has improved since the last time I look at it. These new deals provide far more flexibility moving forward and should accelerate the firm’s recovery. But personally, I remain un-tempted to add it to my portfolio. Why? Because I believe there are better opportunities elsewhere.
