Being a passenger on a plane powered by Rolls-Royce (LSE: RR) engines can be a comfortable ride. Sadly the same is not true of being a shareholder in the aeronautical engineer. Rolls-Royce shares have tumbled 37% in the past year alone. Over the past five years, the stock lost almost three quarters of its value.
But if any company understands the principles of recovering from a steep loss of altitude, it ought to be an aircraft engine maker. So, as I decide to continue holding my stake in the firm, could 2023 be a year when Rolls-Royce rewards my faith?
I think it may be. Here is why.
Strong foundations
Rolls-Royce has not looked like a great business in recent years, between weak demand and an alarming profit and loss account.
However, a lot of that is down to factors outside the company’s control, such as shifts in demand for passenger flights. I do not like it when a business is heavily affected by such external events. Unfortunately, though, it goes with the territory for aircraft engine makers.
Despite that, I continue to believe that the company has strong foundations. Researching, manufacturing and servicing engines is a highly skilled enterprise with significant barriers to entry. That means that only a handful of companies globally can do it at scale – and Rolls-Royce is one of those. That could help it make juicy profit margins over the long term. Indeed, many engine sales are tied into servicing deals that can run for decades and end up generating more revenue than the initial sale.
Favourable environment
I think 2023 could give Rolls-Royce an opportunity to showcase its potential more fully than recent years.
Globally, travel is getting closer to normal, although demand has not yet fully recovered to 2019 levels. In the four months to October, large-engine flying hours in the company’s civil aerospace division were at 65% of their 2019 levels. That compares to 62% for the first 10 months of this year in total. If that improving trend continues, I expect the company to benefit from Rolls-Royce’s customers — airlines — flying their planes more. This, of course, would translate to higher servicing revenues.
On top of that, I think the company is likely to benefit from increased defence spending in many markets.
Set against that, although the company has recently repaid £2bn of debt, its balance sheet remains a risk. Servicing existing debt could continue to dent profits — and push the prospect of a reinstated dividend further into the future.
I’m keeping my Rolls-Royce shares
With positive momentum and a leaner, more focussed business than several years ago, I think the company is poised to benefit from positive business trends in 2023. Hopefully that could boost the price of Rolls-Royce shares.
Trading for pennies today, compared to the £3 level the shares were hovering around pre-pandemic, they still look like good value to me. I will not be buying more for my portfolio as I already own a fair number. But I will be hanging onto those, hoping that next year could boost their value.
