The Rolls-Royce share price is up 20% year-to-date, after hitting an 18-year low in 2020. But the stock is down 15% in the last month, as the company's exposure to the airline industry concerns investors.
Rolls-Royce share price up this year, but Omicron weighs on sentiment
Rolls-Royce has made a hard-fought recovery of sorts this year, but it's mainly come after the company surprised markets on 5 August with its announcement of an unexpected half-year profit of £393m, beating consensus expectations of a small loss.
This was helped by a better than expected £600m improvement in free cash flow, which, while still negative to the tune of -£1.17bn, was still a significant improvement on a year ago.
In the weeks and months after 5 August, the share price made decent gains, before stumbling in November as concerns over rising cases of Delta infections and the emergence of the Omicron variant led to fresh travel restrictions.
Rolls-Royce shares are currently trading at around 123p, down from their November peak of 150.48p.
Rolls-Royce pressing ahead with cost-cutting measures
Rolls-Royce has taken significant steps in the last 12 months to reduce head count and cut costs, and reiterated on its Q3 earnings call this morning that it was on course to achieve its £1.3bn savings target by the end of 2022.
While this is welcome news, the business continues to rely on the civil aviation sector, with a large proportion of its revenue linked to large engine flying hours (EFH). While EFH has improved following the return of transatlantic travel, it could still fall short of the company’s full-year target, which was for EFH in 2021 to reach 55% of 2019 levels..
Nonetheless, today’s Q3 update has shown that things are moving in the right direction. EFH reached 50% of 2019 levels in Q3, putting year-to-date EFH at 46% of the 2019 figure. Meanwhile, the £1.9bn deal with the Pentagon for its F-130 engines, which will be used to power the B-52 Stratofortress for the next 30 years, was a notable win.
The company also said it became cash flow positive in Q3, and that it expects its free cash outflow this fiscal year to be better than previous guidance of £2bn.
However, international travel is set to remain a headwind, with government-imposed travel restrictions likely to remain in place into 2022.
On the plus side, the balance sheet is in better shape as Rolls-Royce met its £2bn disposal target in September, aided by the sale of its Spanish unit, ITP Aero, for €1.7bn. The deal is expected to complete in the first half of next year.
Rolls-Royce's Small Modular Reactor (SMR) business is also gaining traction after the government put in £210m on top of the £145m received from private investors, as the company ramps up its contribution to cutting the UK's carbon output.
Rolls-Royce upbeat despite challenges
Commenting on its full-year outlook, the company said it is making good progress and is on course to achieve its goal of becoming free cash flow positive by the end of the year. The challenge will be in ensuring they can stay free cash flow positive. The company still has a way to go if it is to reach its target of being free cash flow positive to the tune of £750m by the end of 2022.
Much of this will depend on the lifting of international travel restrictions. With all the uncertainty on that front, it will be a challenge for Rolls-Royce to meet expectations for EFH to exceed 80% of 2019 levels in 2022.
However, in spite of these challenges, today's Q3 update delivered positive news in areas of cash outflow and cost cuts, as areas of the business away from civil aviation perform well. That said, the Rolls-Royce share price may continue to struggle, with investors seemingly unable to look beyond concerns over the future of international travel.
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