Rolls-Royce (LSE:RR) shares were hit hard in the pandemic and are currently down 24% in the year to date. This begs the question: is the Rolls-Royce share price cheap and can it lift off in 2022?
Let’s explore whether I’d buy Rolls-Royce stock today.
The bull case for Rolls-Royce shares
For decades Rolls-Royce has focused on aero-engine manufacturing. Last year, civil aerospace was the biggest revenue stream for Rolls-Royce at over £4.5bn. Although this division of Rolls’ business lost £172m in 2021, it’s a substantial improvement on the £2.5bn loss it suffered in 2020.
With wide global vaccine coverage and the arrival of the less severe Omicron variant, governments around the world have been relaxing coronavirus restrictions (although some have also reintroduced them). Rolls-Royce shares stand to benefit from recovering demand for international travel. As its airline customers (including IAG and Virgin) return to the skies, Rolls’ civil aerospace division could bounce back to profitability.
Rolls-Royce is also a market leader in defence aerospace. The company turned a £457m profit in this area last year. Moreover, the UK government committed to an additional £24bn in defence expenditure over four years in its 2020 Spending Review. Russia’s invasion of Ukraine is increasing pressure for spending to rise further — this bodes well for the Rolls-Royce share price.
Beyond its core aerospace operations, Rolls-Royce is also going nuclear by developing small modular reactors. With £450m in funding secured from private investors and government grants, the company plans to build 16 mini nuclear plants across the UK. Achieving net zero is a central goal for the UK government. Accordingly, this project could be an important future revenue source for Rolls-Royce.
The bear case for Rolls-Royce shares
It’s not all rosy for the stock. Despite returning a £414m underlying operating profit last year, the company’s balance sheet remains problematic. Net debt ballooned from £3.6bn to £5.2bn in 2021 and underlying earnings per share stood at a meagre 0.11p. After years of poor financial results, it’s unsurprising the Rolls-Royce share price has substantially underperformed the FTSE 100 index in a decline to penny stock levels.
Furthermore, as an investor who likes passive income stocks, Rolls-Royce shares disappoint. The board decided it wouldn’t recommend a final shareholder dividend payment for 2019 and hasn’t issued dividends since. Under the terms of recent loan facilities, Rolls-Royce is restricted from paying dividends until 2023 — and only after satisfying certain conditions.
Finally, at the end of March, excitement surrounding a possible takeover of Rolls-Royce lifted its share price. However, I’m sceptical that the UK government would ever permit this. It owns a ‘golden share’, giving it veto power over any such deal. While this arguably makes Rolls-Royce too big to fail, restrictions on M&A activity limit the company’s future growth prospects, in my opinion.
Would I buy?
Currently, I wouldn’t buy shares in Rolls-Royce. Although certain macroeconomic conditions are improving for the company, weak financials and the absence of dividends mean I don’t see the shares enjoying a significant rebound any time soon. With CEO Warren East leaving at the end of 2022, I’m waiting for uncertainty to subside and the company’s debt position to improve before adding Rolls-Royce to my portfolio.
