The Rolls-Royce (LSE: RR) share price is up by 40% over the last 12 months. And in November so far, the shares are up 10%, so the stock has significant momentum right now.
I’ve been a naysayer when it comes to Rolls-Royce as an investment. The question now is: should I change my mind and add the shares to my portfolio?
Why could the future be better?
Rolls-Royce has secured backing from a consortium of private investors and the UK government to develop small nuclear reactors to generate cleaner energy. This news could have helped convince investors that this may be a potential source of new income for the firm. Coming at the same time as COP26 and a focus on moving away from fossil fuels, this may have heightened optimism about the future role of nuclear.
Other than that, Rolls-Royce is, I think, gaining from a general pandemic recovery, which seems to be benefiting large-cap shares in particular right now. Some lower-growth mature UK shares such as WPP, Marks & Spencer and others are bouncing back strongly. The FTSE 100, it should be noted, is also rising from a weak early autumn.
Another plus is that just this month, Rolls-Royce completed the sale of its civil nuclear instrumentation & control (I&C) business to Framatome. This helps it towards its target of generating at least £2bn from disposals and could go some way towards helping repair the balance sheet. The latter is much needed in my opinion. The latest disposal follows a September announcement that the engineer had signed a definitive agreement to sell 100% of ITP Aero for approximately €1.7bn to Bain Capital Private Equity.
What concerns remain?
Despite the disposals, possible new business growth opportunities in nuclear and an expected recovery in aerospace as long-haul flights pick up again (notably between the US and the UK), I still have concerns.
Primarily there’s the increase in debt and the havoc the pandemic has wrought on the balance sheet. For example, net debt is approaching £5bn.
Then there’s the question lodged in my mind about the impact of the Trent engine problems on Rolls’ reputation. The problems with those engines persisted for a long time and the company is still setting aside provisions. It’s hard to quantify the long-term impact, but I fear that the problems may harm its relationships and therefore future profits.
To add or not to add?
The recent share price boost is no doubt being welcomed by existing investors, but do I want to become one of them? Potentially, Rolls-Royce could be a speculative buy for me, but when it comes to a FTSE 100 engineer I actually prefer Melrose. I also think the impact of the pandemic could be felt for many years and so I won’t be adding any Rolls-Royce shares to my portfolio. Clearly though, as the upward share price shows, many in the market disagree with me, but I’m staying away for now.