It’s been over two years since the pandemic decimated the Rolls-Royce (LSE:RR) share price. Yet despite the impact of Covid-19 diminishing, shares of the engineering continue to drag their feet. Over the last 12 months, the stock has continued its downward trajectory falling by a further 25%.
The latest interim results didn’t seem to impress most investors. However, despite the pessimism surrounding this company, I’ve spotted a few signals of growing strength. Is Rolls-Royce’s stock price bound to return to its pre-pandemic glory? And how long will this recovery process take?
The Rolls-Royce share price could recover by 2024
After a quick glance at the latest results, it’s easy to see why investors we’re exactly thrilled. Underlying revenue was basically flat versus a year ago with only a 1.5% boost. Meanwhile, operating margins were slashed from a tight 5.9% to 2.4%.
The lack of government support with furlough schemes caused administrative costs to rise by 16%. And when paired with inflationary pressures, the bottom line landed back in the red. So watching Rolls-Royce’s share price tumble on these results isn’t all that surprising.
However, something which I believe has been overlooked is the state of free cash flow. While also in the red at £68m, that compares to the massive £1.2bn and £2.9bn holes in 2021 and 2020 respectively. This improvement was driven by increased trading activity within its civil aerospace division. Thanks to a 33% surge in total flying hours of its engines, the segment saw a £1.13bn improvement in trading cash flow, landing it back into the black at £63m.
Meanwhile, power systems achieved a record level of order intakes, and its defence segment is also having little trouble boosting its order book. The latter did report a 9% reduction in revenue. However, this seems to result from a drop in spare engine sales, which management expects to normalise later this year.
The lack of profitability is understandably frustrating. But in the end, cash is king. And with the firm’s free cash flows being substantially stronger, the future of this business looks far less bleak, in my opinion.
Management expects its civil aerospace division to return to pre-pandemic activity levels by 2024. And since this division was the chief victim of Covid-19, I suspect the Rolls-Royce share price will recover alongside it.
Time to buy?
As encouraging as the firm’s re-enforced cash flows are, debt remains the giant elephant in the room. The group also has just under £8bn of loan obligations. Needless to say, that’s not ideal when interest rates are climbing. As such, profit margins may continue to face increased pressure moving forward, impacting the firm’s overall recovery progress.
On the plus side, Spanish regulators have given its previously announced sale of ITP Aero the green light. With £1.3bn of capital flooding the balance sheet, the business should be able to wipe out a good chunk of its obligations.
While that still leaves a monumental pile of debt to service, the improving state of cash flows suggests the cracks in the balance sheet are starting to be repaired. That’s why I’m cautiously optimistic about the Rolls-Royce share price and, for the first time in a long time, I’m tempted to add a small position to my portfolio today.
