Is buying Rolls-Royce (RR) shares a good investment?

| April 3, 2022

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Key Points

  • Rolls Royce made notable progress in 2021
  • The company is broadening its horizon by exploring the potential of Space
  • The biggest challenge for the aerospace engineer is to regain investor interest and confidence

Rolls-Royce (LSE:RR) shares have had a rough ride over the last couple of years. As a reminder, this is an £8.3bn company that is engaged in the aero-engine manufacturing business. The ‘Pioneers of Power’ operates under three business segments:

  • Civil Aerospace
  • Power Systems
  • Defence

As per recent announcements, the firm is aiming to become the leading provider of all-electric and hybrid-electric power and propulsion systems for Advanced Air Mobility (AAM). This partnership is proof of its contribution to sustainable aviation. But does that make it a good investment for my portfolio? Let’s explore.

Why Rolls-Royce shares could go up

Despite what Rolls-Royce shares would indicate, the company made notable progress in 2021. Its free cash flow improved substantially thanks to cost reduction, stronger operating performance, and reduced capital expenditure. Also, with the global aviation industry slowly getting back on track, the group seems to be all set for growth. At least that’s what I can see.

Beyond this encouraging restoration progress of cash flows, the aero-engine manufacturer seized multiple new opportunities last year.

  • Secured a contract with US Air Force to power its fleet of 76 iconic B-52 aircraft
  • Ministry of Defence UK announced Rolls-Royce’s role and involvement in the next generation of nuclear-powered submarines.
  • Agreement with Japan’s IHI Corporation to develop and deliver a future fighter engine demonstrator

The bull case for this business

Rolls-Royce calls itself the ‘Pioneers of Technology’. And I think that’s a pretty apt description. Management has a set plan of growth and technological innovation in line. And it even includes further exploration into Space. In fact, it has already signed an innovative contract for 2021 with the UK Space Agency for a study into future nuclear power options for space exploration.

If successful, this deal could open up a brand new avenue of revenue generation. And when combined with the recovering financials from the pandemic, this could be the recipe for long-term growth for Rolls-Royce shares.

Challenges ahead

Rolls-Royce bore one of the highest losses due to Covid-19 up to the level that there were rumours about the UK government stepping in. To stay alive, management was forced to pile up huge amounts of debt to stop the company from going under.

While the decision brought the firm back from the brink of bankruptcy, it’s done some serious damage to the balance sheet. What’s more, this debt is now impeding the recovery progress, especially with rising interest rates.

Understandably, this development has taken quite a toll on investor confidence surrounding Rolls-Royce shares. And it will take a lot more progress, I feel, to restore this business to its former glory.

Will I be investing in Rolls-Royce shares?

With the debt level rising, the firm ultimately cut shareholder dividends which aren’t expected to return until 2024 at the earliest. Hence for investors like me, who historically saw this firm as a ‘secure’ income investment, that story is no longer true.

On the other hand, I believe the business has improved considerably in the past few quarters. In its annual report for 2021, the company reported £414m of underlying operating profit from continuing operations. Undoubtedly, this profit is a significant improvement from the loss generated in the previous year.

Looking at the current situation of the business and keeping in mind the plans, I believe the worst is now over for Rolls-Royce’s shares. Therefore, I am considering opening a small position within this business as a long-term investment.

Learn more about Rolls-Royce

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Saima Naveed does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.