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Rolls Royce ( LSE:RR ) shares are trading around a quarter of what they were in 2019. FTSE 100 Strong.
The pandemic has posed many challenges for the UK-based engineering giant. Flying hours fell, meaning Rolls earned less on ‘hourly power’ commercial contracts. As governments focus their resources on Covid-19, there is also a reduction in defense spending.
However, as we move on from the pandemic, Rolls-Royce’s share price is still pushing downwards. So let’s take a closer look at the company’s fortunes and why I’m not putting my money in a 3% savings account but buying Rolls Royce shares.
First, it should be noted that Rolls still has several headwinds. The company took on a lot of debt during the pandemic and recently completed a sale of business units to raise £2bn. A portion of this will be used to reduce the company’s debt burden. The business had net debt of £5.1 billion as of June.
There are also growing economic problems. Rolls-Royce engines are widely used in long-haul aircraft. But as the global economy spirals into reverse, there may be less demand for long-haul travel, slowing the post-pandemic recovery.
The case of the bull
Rolls-Royce has impressive revenue generation potential. In fact, the company earned around $15 billion in revenue last year, more than double its current market cap. However, this is down significantly from the $21 billion created in 2019.
The biggest challenge is to return to pre-pandemic levels of profitability. In the six months to June 30, the group saw profits fall to £125m from £307m in the same period a year ago. Rolls highlighted that this was partly due to £371m of research and development expenditure on defense and power systems.
But there are many reasons to be positive. First, the civil aviation industry is returning to pre-pandemic levels. It’s not there yet, but flight hours are definitely increasing quarter by quarter, and this will have a big impact on revenue generation.
Long-term trends are also positive. Aviation has some huge growth markets including fast developing countries like India.
The company has a strong order book in other sectors Power System and Defence. And this gives him good visibility in the future. Defense is also likely to be strengthened further, as new Prime Minister Liz Truss wants to see UK defense spending hit 3% by 2030.
And in general, it’s important to note that Rolls-Royce operates in industries that place a high value on quality. And this creates high barriers to entry. Yes, the company already has competitors in the West, but I think we are unlikely to see companies in developing countries start to challenge Rolls here.
Currently trading below 80p, I see now as a good time to buy more of this stock for my portfolio. And I believe my returns will be more than people’s savings account next year.