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Did Rolls-Royce’s £5.1bn debt widen in H1?

Close-up of a Rolls Royce bonnet with the logo

Ahead of its half-year results on 4 August, Rolls-Royce [RR] has named BP veteran Tufan Erginbilgic as the person to replace Warren East as chief executive next year. Chair Anita Frew has hailed him as “a proven leader of winning teams within complex multinational organisations, with an ability to drive a high-performance culture”.

Investors will be hoping that Erginbilic, who will take up the role on 1 January, can bring value back to the Rolls-Royce share price, which had fallen 29.75% since the start of the year to 89.27p at the close on 29 July. Although the stock has recovered 14.65% from a 52-week low of 77.86p on 11 May, it has plummeted 44.8% since setting a 52-week high of 161.91p on 10 December 2021.

The stock failed to take off following Q1 earnings on 13 May and has been trading within a limited range since. While long-term flying hours were up 42% in the four months to the end of April, meaning more jet engines needed to be serviced, civilian travel hasn’t yet rebounded to pre-pandemic levels.

Operations put pressure on debt

Overall, first-quarter trading was in line with expectations and the company reiterated full-year guidance of low- to mid-single-digit revenue growth. It also advised that operating margins will be lower than in 2021 due to increased investment as the company wins contracts in its defence segment. Cost reductions will help it to achieve positive free cash flow in the second half of the year.

“This is a key turning point for [Rolls-Royce], which has seen its debt pile balloon as billions walk out the door to keep operations turning over,” said Hargreaves Lansdown equity analyst Laura Hoy, according to This is Money.

Debt stood at £5.1bn at the end of fiscal year 2021. The disposal of Spanish arm ITP Aero for £1.5bn, which should be completed in a matter of weeks, “will help get this under control, but ultimately we’ll need to see a business capable of standing on its own two legs before popping the champagne,” Hoy added.

Tools to navigate inflationary pressures

The Rolls-Royce share price could get a boost if half-year results show signs of free cash flow improving.

The company’s defence segment has a strong order book, which should have helped the company to mitigate any inflationary pressures during the first half of the year. Frew indicated in May that she expects “governments to increase their long-term budget allocations, which will improve long-term growth prospects for our defence business”.

Order intake for Rolls-Royce’s power systems business was robust in the first four months, and the business has managed to build up a buffer of inventory to manage supply chain disruptions. The segment is expecting weaker cash conversion this year, although that’s due to inventory management to navigate supply chain disruptions.

While the company may have the tools to withstand current market conditions, three out of four analysts expect Rolls-Royce shares to underperform the market, according to data collected by SharePad as seen by Proactive Investors. UBS analyst Kseniia Maslova reiterated a neutral rating in July and cut the stock’s target price from 144.5p to 102p, implying an upside of 14.3% from the most recent closing price. Maslova cited a slow recovery in flying hours in the first half of the year, especially in the Asia-Pacific region, and inflation risks as two headwinds that could impact Rolls-Royce’s half-year results.

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