Rolls Royce (RR.) is one of the most famous British companies, and even though it no longer associated with the car brand, it is still renowned around the world for its engineering prowess. But despite its reputation, it has struggled in recent years and the arrival of Covid-19 in combination with a poor set of results for 2019, not to mention impending debt repayments, caused the share price to plummet back in late February and throughout March. Since then, apart from a brief recovery in early June when the markets bounced back, it has seen a further decline and is now trading at close to an 85% discount compared to where it was a couple of years back...
Whilst its defence business has remained strong, and power systems have seen lower levels of decline, it was hammered to the tune of a cash outflow of circa £3 billion during the first half of the year largely down to reduced engine flying hours and engine deliveries, plus invoice factoring. The company was expecting improvements during H2 2020 and had given guidance for cash outflows of £4 billion, but it remains to be seen whether that could be even higher if we do get a serious second wave and further widespread lockdowns. Its interims showed that it still had available liquidity of in excess of £8 billion, via existing and new debt facilities, plus it is trying to strengthen its balance sheet via the disposal of its ITP Aero business for at least a £2 billion sale price – assuming of course that a buyer emerges. Its assets are still of significant value with over £33 billion recorded on the balance sheet, but it has over £41 billion of total liabilities, with over £14 billion of that in the form of loans, lease and other financial liabilities.
A couple of weeks back the company issued a statement in response to speculation in the media, stating that it was indeed looking at ways to further strengthen its balance sheet, which could include debt, equity or a combination of the two – alongside the cost saving measures which it has already put in place. Subsequent to that it made a further announcement that it may look to raise £2.5 billion via an equity raise. On Friday there was further media speculation, including Sky News reporting that the Kuwait Investment Office was negotiating a deal to take part in such an equity raise, to the tune of £250 million. With the same amount also being linked to Singapore’s Government Investment Corporation. Given that the share price is now only around 155p the market cap of the company is just £3 billion, and that means that any such investment would be significant. One aspect of all of this which I haven’t seen being reported as widely though is the fact that the UK Government holds a ‘golden share’ and due to the sensitive nature of the business that Rolls Royce is involved in, it has the power to block investment by foreign government funds if that is seen as a potential security risk. Whether or not that will actually come into play here or not all comes down to the terms of the funding, and it may well not be the case that it even comes into play at all, as it was added to the Rolls Royce articles in 2015 and imposes a limit of 15% of the shares in issue being held by any individual foreign shareholder. So if the rumours are true and it does engage in a £2.5 billion rights issue in the coming weeks, both foreign governments mentioned would remain below that limit if they were to take an investment of the size rumoured (£250 million each).
What is clear though is that the company is going to refinance its balance sheet in some way, given the future uncertainties over Covid, and if that comes via a rights issue alongside investment from sovereign funds, it seems highly likely that it will happen at a lower level than the current share price. Personally, I think that long term Rolls Royce will recover - flying/aviation certainly hasn’t suddenly ended and will resume at similar levels again in the future, I’m sure - but until funding is confirmed I would expect to see further weakness. Certainly, the share price movement towards the close on Friday suggests that, and I suspect some shorts took advantage of the spike in price, although there are no real large notifiable positions, with just 1.62% between two funds in terms of positions over the 0.5% threshold. I just can’t see any real reason to be buying now and taking on risk, as even after refinancing it isn’t suddenly going to rocket overnight, the way the markets in general are looking and with Covid cases and lockdowns on the rise. The sensible play to me seems to be to wait until the uncertainty over funding is out of the way, and then to buy in with a long term view that the company could make a decent recovery over the next five years or more. It is definitely one which I would then consider putting into a SIPP.
Filed under: Rolls Royce, Ariana Resources, Falanx, AA, Hotel Chocolat, Greggs, TomWinnifrith.com
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