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How could Rolls-Royce’s share price be affected by an income slump?

There’s a long road ahead for Rolls-Royce’s [RR] share price.

On 9 July, Rolls-Royce’s share price dived 10.9% from 287p to 256p after the company warned that its income would drop over the next seven years in a horror show first-half trading statement.

Rolls-Royce’s share price was hit by the company’s announcement that it was closing a third of its $37bn denominated hedges in anticipation of reduced flying hours and aero-engine sales in the wake of the coronavirus pandemic. The cash cost of this move will be £1.45bn over seven years, and the manufacturer also reported a free cash outflow of £3bn in the first half of 2020.

Adding further insult to injury, the company said engine flying hours would see a 55% reduction across the full year. Rolls-Royce’s share price has fallen 59.7% from a high of 699p on 12 February to just 281p on 20 July.

So, what will this mean for Rolls-Royce’s share price in the longer term?

 

 

Rolls-Royce’s share price: How low can it go?

Rolls-Royce announced in May that it was cutting 9,000 jobs from its 52,000 strong employee base, and said it expects to make cost savings of up to £1bn this year. These savings could help to bolster Rolls-Royce’s share price, but such a large reduction in the workforce could harm investor sentiment in the long-term.

The statement continued by saying that during these “exceptional times” the company could look at disposals, refinancing or an equity issue to help it survive.

“The COVID-19 pandemic has created a historic shock in civil aviation which will take several years to recover,” said CEO Warren East.

“The COVID-19 pandemic has created a historic shock in civil aviation which will take several years to recover” - Rolls-Royce CEO Warren East

 

Nick Cunningham, aerospace analyst at Agency Partners, recently told the Financial Times that Rolls-Royce’s share price could fall as low as 100p before rebuilding. “We are close to having sight of the worst point,” he said. “There is subsequent potential for substantial equity upside.”

Joe Healey, Investment Research Analyst at The Share Centre, told Opto there is likely to be a long journey ahead, and any improvement in Rolls-Royce’s share price relies on the uncertain recovery of the airline industry. After all, he notes, the company derives more than 50%  through their civil aerospace segment.

“On top of this, you have large amounts of debt, engine issues and a weak demand outlook,” Healey said.

“Costs at Rolls-Royce have been growing for many years, so large reductions in head count and a stronger focus on the more profitable areas of the business should help reduce the strain on the cost side,” he added, suggesting that there may be better times ahead for Rolls-Royce’s share price. A long overdue restructuring and the expected completion of its Trent 1000 engine fixing programme in 2021 could help the company get back on track.

“We’re already starting to see tangible benefits of this, with the £1bn savings this fiscal year,” Healey states, as well as noting the company’s unrivalled technical prowess. It is “well-positioned in the transition to more efficient aircraft” as the industry as a whole is poised for a shift towards sustainable goals.

“Costs at Rolls-Royce have been growing for many years, so large reductions in head count and a stronger focus on the more profitable areas of the business should help reduce the strain on the cost side” - Joe Healey, Investment Research Analyst

 

Pivoting towards sustainable growth

Kirsteen Mackay highlights another area of promise for Rolls-Royce’s share price — the company’s R2 Data Labs project, which is aiming to utilise big data and artificial intelligence in order to deliver future technologies.

“Establishing a complex virtual environment gives [Rolls-Royce] a futuristic way of analysing the performance of everything it builds. This will no doubt help it in its aim to deliver planet-friendly power solutions,” she wrote in the Motley Fool.

This diversity could also help the company deal with the aviation crisis. “While its aviation business is suffering, its defence business has been coping,” Mackay said. 

“Establishing a complex virtual environment gives [Rolls-Royce] a futuristic way of analysing the performance of everything it builds. This will no doubt help it in its aim to deliver planet-friendly power solutions” - Kirsteen Mackay

 

What’s the outlook for Rolls-Royce’s share price?

Both Mackay and Healey recommend that investors remain cautious.

Mackay said that, despite the company’s successful past and the promise of technological innovation, “considering the uncertainty ahead for international air travel, its troubles are far from over. There is no dividend on offer to sweeten the deal, and I think its share price could well have further to fall.”

Healey added: “With the share price so low, some would point to the upside, however, the uncertain aviation outlook and internal issues could very easily change that.”

Among 11 analysts polled by MarketBeat, the consensus is to hold the stock, with four offering this rating. Four others rate it a buy and three a sell.

 

Market Cap£5.102bn
EPS (TTM)-69.10
Operating Margin (TTM)-4.8%
Quarterly Revenue Growth (YoY)5.6%

Rolls-Royce share price vitals, Yahoo Finance, 24 July 2020

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