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 Holdings Plc (LSE:RR) shares have had a rough ride over the last couple of years. As a reminder, this is a £6.3bn company listed on the London Stock Exchange specialising in power, automotive, defence, and aerospace sectors. 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 the 34% drop in Rolls-Royce shares over the last 12 months would indicate, the company has made some notable progress in recovering from the pandemic.

In 2021, its free cash flow improved substantially thanks to cost reduction, stronger operating performance, and reduced capital expenditure. Beyond this encouraging restoration progress of cash flows, the aero-engine manufacturer seized multiple new opportunities last year.

• It 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.

Jumping ahead to the first half of 2022 and this admirable performance has continued, in my opinion. Management’s strategy is still now about managing the impact and challenges of rising inflation.

Underlying revenues improved by 4%, hitting £5.4bn largely thanks to a rapid recovery in its Power Systems division which saw another record of order intakes.

Obviously, this isn’t groundbreaking. But when paired with the improvements in flying hours from its Aerospace segment, free cash flow came in at £68m. Again, this may not seem like much, but it’s £1.1bn higher than a year ago!

Supply chain disruptions, the Ukrainian war, and Covid are still having a tangible impact on operations. And are undoubtedly dragging down Rolls-Royce stock.

Yet, with the approved sale of its ITP Aero business, management seems to be steering the ship back in the long-term value-building direction. At least, that’s what I think.

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, in 2021, it signed an innovative contract 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 having to step in on fears of a stock bankruptcy. To stay alive, the firm 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 that investors ought to consider. 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?

Investor interest has been reignited in Rolls Royce shares with the news of the company aiming to reduce its debt.

However, according to analyst forecasts, it still has a long way to go, with dividends unlikely to re-emerge until 2024. That means the company can no longer be classified as a “safe” or reliable income investment in my mind.

Having said that, there’s no reason why it can’t regain that status in the future. In the past few quarters, I believe the business has improved considerably.

In its half-yearly report for 2022, the company reported £125m of underlying operating profit from continuing operations. And even though margins suffered slightly, this is expected to reverse as we enter the second half of its 2022 fiscal 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 cautiously optimistic about the future performance of its share price and am considering opening a small long-term position within my portfolio.

Learn more about Rolls-Royce

• Is the Rolls-Royce share price too cheap to miss?
• What will happen to the Rolls-Royce share price in 2022?
• Can the Rolls-Royce share price recover in 2021?
• Where is the Rolls Royce share price going?

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.