Rolls-Royce (LSE: RR) has seen its share price plummet over 30% this year to penny stock levels. However, recent developments leave me excited for the company’s future. The British manufacturer has managed to secure a couple of big deals, but whether these are enough to spark a share price recovery remains questionable.
A new dawn
The news from Rolls-Royce earlier this week certainly got me excited. After years of speculation as to whether the Qantas Project Sunrise would come to fruition, the Australian airline has followed through with its plans. The project is set to “operate the world’s longest commercial non-stop flights, allowing passengers to fly direct between London or New York to the Australian east coast cities of Sydney and Melbourne.” As a result, Qantas is purchasing 24 Trent XWB-97 engines to power the 12 Airbus A350-1000s it has on order. Additionally, the two parties have committed to a TotalCare service agreement for the engines. The service outsources engine maintenance and management to Rolls-Royce, bringing additional revenue.
So, how much does Rolls-Royce stand to gain from this deal? According to experts, a Trent XWB engine costs approximately $35m per unit. Pair that with the TotalCare service, and the FTSE 100 company could stand to profit close to £1bn from this deal over the next few years.
Bomber contract
An even bigger contract is the B-52 Commercial Engine Replacement Program Rolls-Royce has with the United States Air Force. Last year, Rolls-Royce was selected to replace the USAF’s old B-52 engines. In total, the deal is worth a staggering $2.6bn.
Despite the large deal value however, investors should read beyond the headlines. So far, the agreement has only been for an initial $500m over six years, with options to bring the total deal value to $2.6bn over 17 years. Although the potential value is massive, that $2.6bn isn’t a huge amount over the course of two decades. There’s also a risk that the USAF may not exercise the options available in the contract to its full amount, limiting Rolls-Royce’s future revenue.
Clear for take-off?
While the firm has managed to secure reasonably good deals, I don’t see the Rolls-Royce share price taking off any time soon. For one, I think the impact of the recent cancellations of many Airbus A330neos is yet to be felt by the manufacturer. I will be hoping to find clarification on this in next week’s Q1 trading update.
| Engine Type | Airframe | Market Share | Engines in Service | Engines on Order |
|---|---|---|---|---|
| Trent XWB | Airbus A350 | 100% | 764 | 613 (+24 after Qantas deal) |
| Trent 7000 | Airbus A330neo | 100% | 130 | *150 (550 before cancellations) |
| Trent 1000 | Boeing 787 | 33% | 604 | 122 |
| Trent 900 | Airbus A380 | 48% | 168 | 1 |
| Trent 800 | Boeing 777 | 40% | 176 | 0 |
| Trent 700 | Airbus A330 | 60% | 1,146 | 0 |
| Trent 500 | Airbus A340 | 100% | 92 | 0 |
| Total | 3,080 | 1,097 |
Secondly, although the travel industry has tailwinds backing it, consumers are starting to feel inflationary pressures. This may affect demand for air travel, and aero engines. Finally, JP Morgan‘s bearishness on the firm’s ‘New Markets’ segment isn’t boosting investor sentiment. The investment bank doesn’t think the division will turn a profit given the amount of capital Rolls-Royce has pumped into it. Therefore, although the company has a promising future, I don’t think the benefits outweigh the risks involved for me to invest in Rolls-Royce.