The Rolls-Royce (LSE:RR) share price, and the stock market in general, has welcomed a bit of a rally over the last few days. After early data showed that existing vaccines will be effective against the Omicron variant, investors’ nerves have somewhat calmed… for now.
However, current UK infection rates are nearing all-time highs, with Omicron acting as a driving force. As such, the probability of another round of lockdowns is climbing. And if it’s anything like what we saw in 2020, Rolls-Royce could be in for further disruption. But can the company prevail?
Lockdown potential
Rolls Royce has several sources of income as its divisions, focus on a variety of sectors. However, revenue from its aerospace segment represents a large chunk of its cash flow. So it’s not surprising that after travel restrictions were put in place in 2020, this source of income quickly, albeit temporarily, dried up. That’s undoubtedly why the Rolls-Royce share price collapsed in March last year.
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Since then, the stock has made a slight recovery. But its 12-month performance is still basically flat, and it continues to trade below pre-pandemic levels. Yet the underlying business has made some encouraging progress, in my opinion.
Looking at today’s trading update, free cash flow is on the rise, thanks to recovering order volumes. As such, management forecasts that it will come in higher than its initial 2021 target of £2bn.
Meanwhile, the company has undergone a major structural overhaul that has delivered over £1bn of savings so far this year. Combining that with a further £2bn of cash from the disposal of non-core assets, Rolls-Royce’s balance sheet is looking much stronger than at the start of 2020. At least that’s what I think.
This is undoubtedly encouraging news, but is it enough to survive another round of lockdowns if harsher restrictions were brought in?
2022 could be a challenging year
Assuming the worst-case scenario, 2022 might see the return of both travel and lockdown restrictions. Needless to say, this could reverse much of the solid recovery progress made by the aerospace industry. And it would likely once again disrupt Roll-Royce’s supply chain for all its divisions, as well as reduce demand for its services.
The increased cash balance does provide the firm with more flexibility than the previous time. However, that capital might not last long, especially since £300m of original equipment expenses are now expected to land in 2022. Should Rolls-Royce’s revenue stream once again evaporate, and the cash reserves get depleted, then I think it’s likely the share price will take a tumble.
So can the stock survive?
All things considered, while there may be volatile times ahead, I believe Rolls-Royce is capable of persevering. However, should the worse come to pass, even if the business survives, it may be years before its share price can return to its former glory.
Personally, I think there are far better investment opportunities for my portfolio elsewhere.
