The Rolls-Royce Holdings (LSE: RR.) share price has put in a cracking recovery. From around 65p back in October 2022, it’s now up around 150p.
But it did take a bit of a dip in the past week, as the FTSE 100 stumbled. The shares still seem reasonably stable. But confidence does not look rock solid yet.
It might not take much to send investor sentiment into a tailspin again. And I can think of three things that might put the Rolls-Royce recovery back on hold.
Cash and debt
Net debt fell by nearly £2bn in 2022. That headline figure is impressive, but it needs closer inspection.
Rolls said the reduction was funded by disposals and improved cash flow. Disposals came to £2bn, with the sale of ITP Aero making up the biggest part. So it sounds like disposals alone would have raised enough.
Now free cash flow did turn positive, at £505m. And that’s a genuine achievement. But it’s still a long way from paying off the remaining net debt of £3.3bn.
I think investors expect accelerating cash flow now. And if they don’t see it grow fast enough to satisfy them, I fear they might dump the shares.
The share price recovery is impressive, but is the valuation getting a bit too hot now? A price-to-earnings (P/E) valuation can be misleading at a time of turnaround.
But forecasts put Rolls on a P/E of over 30 for this year. And it’s still above 20 in 2024. If we adjust those for debt, the equivalents come in at 38 and 25 respectively. That might be a bit too rich.
Investors who bought Rolls-Royce shares before this year’s rise might want to pocket some of their gains. So a bit of profit taking could send the shares down.
I’m just not sure there’s enough safety margin in the current Rolls-Royce share price to cover the risks.
Let’s think about those risks. It’s easy to assume that, pandemic over, Rolls will quickly get back to business as normal. And maybe the odds are in its favour.
But we shouldn’t forget that Rolls-Royce was struggling even before the pandemic. In the two years prior to the Covid crash, Rolls shares were down 35%.
Thanks to some revolutionary new ideas from Boeing, we could be at the start of a plane design overhaul. Then there are growing green energy pressures.
Technological revolutions provide opportunities for newcomers. And the old companies with last year’s technology can suffer.
I think these are real risks. But I’m still bullish on Rolls-Royce for the long term.
With their financial muscle, I still think the industry leaders can stay at the head of the field. But I reckon it would be a mistake to expect a steady, smooth ride.
I still see volatility ahead, at least until cash flow gets firmly back on track. So Rolls might be one to buy on any future dips. But it’s definitely still on my candidates’ list.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.