Will Rolls-Royce shares keep flying despite “unsustainable” warning?



Jumbo jet preparing to take off on a runway at sunset

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Will the Rolls-Royce Holdings (LSE: RR) share price finally stage a lasting recovery in 2023 (and beyond)?

The jet engine maker has made several false starts over the last couple of years, but I think conditions are now ripe for a lasting turnaround. Let me explain why.

“Burning platform”

Rolls-Royce has been in the financial press recently. The company has a new chief executive, ex-BP man Tufan Erginbilgic.

Mr Erginbilgic has a reputation as “a seasoned operator” with a focus on “performance and driving down costs”, according to a recent profile in the Financial Times.

He certainly seems to have a knack for straight talking. In a recent session at Rolls’ UK base in Derby, he’s reported to have warned staff that the company is “a burning platform” that has been underperforming since long before Covid.

The current situation is “unsustainable”, according to Mr Erginbilgic. My reading of his comments is that Rolls-Royce is likely to face further restructuring, but also possible changes to its business line-up. I wouldn’t rule out further asset sales.

China reopening: perfect timing?

There’s a second factor at work here too. It may just be that Rolls’ new boss has lucky timing.

Covid restrictions in China have meant that global long-haul flying has recovered more slowly than short-haul flying. That’s been bad news for Rolls, whose engines are mostly used on long-haul aircraft.

Now that China has scrapped its zero-Covid policy, I think there’s a real chance that the company will see a strong recovery in engine flying hours.

Rolls-Royce makes most of its money on a pay-as-you-go model. An increase in flying hours should mean an immediate increase in revenue and profit.

City analysts covering the stock expect Rolls’ profits to rise from £47m in 2022 to £278m in 2023. A further step up is expected in 2024.

It might just be that Mr Erginbilgic has timed his arrival perfectly to benefit from a China-led recovery in long-haul travel.

Still got problems

I agree with the new CEO’s argument that Rolls-Royce had problems even before the pandemic. The business model for its engines is complicated and seems to involve selling them at a loss, before recovering the costs through future maintenance payments.

Historically, the group’s accounting has been complex and hard to predict. The company also had a reputation for being bureaucratic, with many layers of management.

Rolls’ debt levels are still high after the pandemic too. Broker forecasts suggest net debt may have been £3.6bn at the end of last year.

Finally, the company needs to face the challenge of adapting to a lower-carbon future.

This could be the real deal

I can definitely see some risks that Rolls-Royce may continue to struggle to deliver decent profit margins and long-term growth.

However, on balance I think there’s a real opportunity here for patient shareholders.

Rolls-Royce has a big market share and good technology. The group also has attractive operations in defence and power systems.

As I’ve said before in recent months, I think this turnaround is the real deal. I see Rolls-Royce as a long-term buy at current levels.


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