At 12.30pm this coming Friday, the London Stock Exchange will close its doors for Christmas. As the bumpy ride of 2022 comes to a close, a few companies are looking severely undervalued. Rolls-Royce (LSE:RR) shares are down an incredible 76% from pre-pandemic highs. In this article, I will analyse whether investing in the company can bring me some festive cheer.
Better days
In February 2018, Rolls-Royce was in a great spot. The company’s share price had grown over 900% in the previous 15 years, compared to 96% for the FTSE 100 as a whole.
Rolls-Royce, while a household name for its luxury cars, actually derives most of its business through aero-engine manufacturing and aftermarket service. This reliance on the aeroplane industry proved to be its undoing.
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Where it all went wrong
In 2020, the company — like the rest of the world — was faced with a crisis in the shape of a novel coronavirus. The Covid-19 pandemic grounded planes across the world for years and, predictably, hit Rolls-Royce’s bottom line. Put simply, when planes aren’t flying, business isn’t coming in.
Here are its revenue figures for the last five years. You can see over £5bn in revenue lost in 2020 and 2021.
| Year | Revenue |
| 2017 | £14.7bn |
| 2018 | £15.7bn |
| 2019 | £16.6bn |
| 2020 | £11.5bn |
| 2021 | £11.2bn |
To keep things ticking over, Rolls-Royce amassed an eye-watering £5.1bn in debt. With lowered revenue and high debt, it’s no surprise the share price is only 24% of its previous figure.
But the debt was accounted for with an eye on the future and the end of the pandemic. So with Covid-19 now largely in the rear-view mirror, is the company seeing an upturn?
Where we are now
In Rolls-Royce’s latest trading update on 3 November 2022, the company stated that large engine flying hours had reached 65% of 2019 levels. That’s still some way off pre-pandemic levels, partly due to persisting Covid-associated lockdowns in China. Outside of civil aviation, its other main sectors of defence and power systems showed robust performance.
Furthermore, the £5.1bn debt resulted in net financing of £236m in the half-year results for 2022. So the underlying operating profit of £125m was brought down to a net loss of £188m (including taxation). This, to me, explains why investors seem cautious and why the share price remains low.
Looking towards the future, the new CEO Tufan Erginbilgic will take the reins on 1 January 2023. He will be tasked with managing and reducing the ominous debt pile, while navigating coming headwinds of inflation and the cost-of-living crisis. This is more evidence of uncertain times ahead for the company.
With conditions as they are, I see a lot of opportunity in the stock market. But I want to stick to companies that look strong for the long term.
For Rolls-Royce, while the debt is an unpleasant prospect, its fundamentals haven’t changed. So at a 76% reduction in the share price, I’m strongly considering a Christmas investment into the company to make my mince pies taste extra sweet.
