Investors in Rolls-Royce (LSE: RR) will not be happy looking at its performance this year. The stock has tumbled 33% as ongoing market concerns have crushed sentiment. The Rolls-Royce share price has also been held back by the crippling effects the pandemic has had on the civil aviation sector.
Yet the stock is showing signs that it can make a recovery as we head into the second half of the year and beyond. But will this be enough for its share price to take off? Let’s explore.
Increased defence spending
Rolls-Royce is set to benefit from the increased focus placed on defence spending in recent times. Its defence division is its second-largest generator of revenue. And with a renewed focus, fuelled by the conflict in Ukraine, the business has already noted a backlog of orders. It generated around 30% (£3.3bn) of its revenues from its defence segment last year. With demand looking set to continue to rise, this could provide Rolls-Royce with a boost.
The firm has also made large strides to become more streamlined. It trimmed its costs by starting a restructuring programme back in 2020. And this would have played a part in the £124m profit the group reported last year. On top of this, it’s also generating free cash flows again. These are all positive signs.
Rolls-Royce debt
What may hinder Rolls-Royce’s recovery is its debt. At the end of 2021, the firm had a net debt of £5.1bn. The recent £1.5bn sale of subsidiary ITP Aero to private equity firm Bain Capital will go some way towards alleviating the pressure. However, as interest rates continue to rise, this debt may become harding to service, bumping up costs for the business. This could have a damaging impact on the Rolls-Royce share price.
The company is also embroiled in a pay dispute with employees amid the cost-of-living crisis. Rolls-Royce recently offered a £2,000 cash lump sum to around 70% of its UK workforce, at a cost of around £45m. But this was rejected by Unite, the union representing workers, which is holding out for an offer more in line with the rate of inflation. Should Rolls-Royce have to increase wages further, this would squeeze the company’s profit margins.
A further issue for me is its high price-to-earnings (P/E) ratio. It currently trades on a P/E of 58. I think this shows the share price is not great value.
Can it recover?
So, can the Rolls-Royce share price recover in 2022 and beyond?
Well, I’m not sure. Increased recognition of defence spending should provide the firm with a boost. However, I think the stock’s price could be dragged down by the headwinds it faces in the near term regarding its pay dispute. Its large debt is also a concern for me. While I like Rolls-Royce, I’m holding out to see if its share price slides further before opening a position in my portfolio.