Rolls-Royce (LSE:RR) shares have actually reversed their downward trend in recent weeks. In fact, Rolls-Royce stock is up 6% over the past five days and currently trades for 91p a share.
The former jewel of the FTSE 100 has been going through some troubling times of late. The pandemic was a watershed moment for the engineering giant, but not in a good way.
However, things are starting to look up.
I already own Rolls-Royce shares, but here’s why I’m buying more before they (hopefully) take off.
The gold standard for quality
We live in an age in which firms from developing countries are increasingly rivalling their Western counterparts. Just look at China’s electric vehicle industry.
However, Rolls-Royce operates in sectors where quality comes at a real premium. Last year, it generated £4.5bn from its civil aerospace division, £3.3bn from defence, and £2.8bn from power systems operations.
The British engineering giant’s name has become a hallmark for quality. And let’s be honest, the last thing you want to hear when you get on a plane is that the two engines were built and developed by a still-new company from a developing market.
It’s a crude analogy I know, but I don’t see Rolls-Royce, and its American peers, being overtaken by Chinese, Russian or Indian firms in civil aviation any time soon. I’d apply a similar logic to defence and power systems. These are industries where high standards and a reputation established over decades really matter.
Signs of recovery
Last week, Morgan Stanley upgraded Rolls-Royce to “overweight” and raised its price target. The bank said that Rolls-Royce’s share price was “the clearest example of mispricing” in its coverage.
“Parsing the recent Civil Aerospace investor day suggests an earnings recovery is much closer than the market has priced in, while earnings and cash flow are directly geared to the next leg of a global aviation recovery,” Morgan Stanley said.
There are clear signs that civil aviation is recovering. Long-term service agreements flying hours increased by 42% year-on-year in the first four months of 2022.
Things are looking up in the defence sector too. Unfortunately this is largely due to Russia’s invasion of Ukraine. The company has noted a strong order backlog in its defence business.
Interestingly, the BAE Systems share price rocketed after Russia’s invasion, while Rolls-Royce shares plummeted. This is largely because investors were worried about the impact on civil aviation. But four months later, the defence business appears to be benefiting from the war.
Efficiency and debt reduction
Debt reduction is important for Rolls-Royce. Because of the pandemic, Rolls-Royce ended up taking on more debt — £5.2bn by the end of 2021. This could certainly impact profitability in the long run.
However, management has a plan and hopes to raise £2bn in total proceeds from the sale of its ITP Aero business and shedding other smaller operations.
Rolls-Royce also completed its £1.3bn cost-cutting programme a year early. Some 9,000 jobs were axed in the process.
I think these moves were necessary to make the business leaner. But it’s worth noting that this could impact future revenue growth.
Risks
Like any investment, there are always risks. Rolls-Royce would be hit hard if Covid-19 were to somehow become more virulent. That’s the last thing the global economy or civil aviation needs right now.
