One of the attractions of owning shares in Rolls-Royce (LSE: RR) used to be the aeronautical engineer’s dividends. But Rolls-Royce dividends disappeared during the pandemic and have not come back yet.
With the aviation industry performing strongly again after a difficult few years, demand for engine sales and servicing has been getting stronger.
Could this mean that we see the return of Rolls-Royce dividends?
Dividend logic
For a company to pay dividends, it basically needs to be profitable.
In reality the two things are not perfectly connected — as long as the business has spare cash it can pay dividends. But without profits, dividends are unlikely.
Indeed, that is why Rolls-Royce dividends were cut in 2020. Pandemic-related travel restrictions meant the business plunged to a big loss and preserving cash became important.
While customer demand for commercial aircraft engines has returned, Rolls-Royce still made a loss last year. It expects to generate underlying operating profits of £0.8bn-£1bn and free cash flow of £0.6bn-£0.8bn this year.
However, operating profits are not the same thing as profits. After all, non-operational costs like interest payments can add expenses.
Right now, management is focused on returning the business to financial health. To date, management has not commented on any planned recommencement of Rolls-Royce dividends. If I was in their shoes, I would not prioritise reintroducing the dividend in the coming year even at a token level.
There is a lot of work still to be done to return the business to sustained, sizeable profits. With nearly 8.4bn Rolls-Royce shares in circulation, even a 1p per share dividend would cost the company around £84m.
Longer-term outlook
That is not necessarily bad for shareholders.
After all, by not paying out dividends, the firm is able to keep money inside the business to fund growth or improve its balance sheet. Rolls-Royce ended last year with net debt of £3.3bn, a sharp reduction on the £5.2bn figure the previous year.
Meanwhile, business has been going well this year. The company reported its largest ever order for Trent XWB-97 engines. Profit margins are set to improve in the power systems division, while robust spending by various militaries should help Rolls-Royce’s defence division in years to come.
The company’s cost-cutting programme could also mean that profitability improves.
At some point, I think growing revenues and a renewed focus on profitability could mean Rolls-Royce dividends will come back. But I would be surprised to see that happen this year.
My move
I also see some risks.
Aviation is prone to sudden unexpected demand slumps. Rolls-Royce is still recovering from the most recent one, but nobody knows when the next one will happen.
Supply chain inflation continues to be a challenge and I see that as a risk to profit margins.
The shares have risen 89% in the past year. I do not currently see them as a bargain. I also do not anticipate Rolls-Royce dividends coming back soon.
For now, I will not be buying.
