After a torrid pandemic period, many analysts, including myself, expected Rolls-Royce (LSE:RR) shares to recover in 2022. However, the engineering firm’s stock is down over 52% in the last 12 months and is amongst the five worst performing FTSE 100 shares for this period.
I have been looking for a quality business to invest £1,000 in before 2023. My criteria are that it must be cheap, offer value, and operate in exciting areas.
While Rolls-Royce shares look really cheap on paper at current levels, is it the best option for my growth portfolio at the moment? Let’s find out.
The positives
Rolls-Royce’s balance sheet is improving. Increasing orders from its civil aviation wing for aircraft engines and maintenance is a positive. While international air travel hasn’t recovered as expected, it is still 52% higher than 2021 levels. This could benefit Rolls-Royce shares over the coming months, especially since the pandemic’s fear has died substantially.
The growth of Rolls-Royce’s new power systems wing is promising. Defence contracts are improving too, fuelled by the Russian invasion of Ukraine.
The company will play a vital role in the US Department of Defense nuclear microreactor program alongside BWX Technologies. This promising development comes after a long line of orders for Rolls-Royce’s nuclear reactor program, including from the UK government.
However, the big question for me here is how will the UK’s struggling economy affect this recovery?
Will the Rolls-Royce share price stagnate?
Firstly, it is not just one stock that is suffering. The Footsie is down 8.5% in the last six months, pointing to a market-wide pullback. However, Rolls-Royce’s struggles are unique in some ways. The blue-chip firm operates in tough sectors like defence, aviation, and energy. It is constantly among the highest-traded stocks in the UK. Despite these factors, investors are exiting fast.
One of the perks of investing when the market is down is that stable businesses often rebound quickly, giving smart investors solid returns in a shorter span. However, I do not see this happening with Rolls-Royce shares. Mounting debt has weighed this business down this year. Net debt currently stands at £5.14bn.
While the £1.4bn sale of ITP Aero will be factored in at the end of this year, debt will still be a concern in 2023. The business returned to profitability in 2021. But due to the high R&D budget, interest payments will continue to chip away at profits for the foreseeable future.
The order book of £6.5bn will help maintain a positive cash flow moving forward. But I have to factor in spendings too. Increasing pressure on renewable power sources means all nuclear projects will be accelerated. This means higher wages and faster turnarounds which will deplete its profits.
New Prime Minister Liz Truss has also stressed the importance of the UK boosting its own oil and gas reserves. Right now, the energy sector looks fractured with the push for renewable energy proving too expensive. How the new leadership chooses to address this will vastly impact industry profits going forward, especially for firms like Rolls-Royce that have invested heavily in renewables.
All this adds to the uncertainty around Rolls-Royce shares which is why I am choosing to keep away at the moment, despite the latest crash.
