While the FTSE 100 navigates choppy waters, it is time to reflect on how some of the top UK companies performed this year. I have been bullish on Rolls-Royce (LSE:RR) throughout 2021. But with things looking dicey again with the surge in Omicron cases, is it time to revisit my stance on the Rolls-Royce share price? Is now a chance to buy at a discount or is the company in for a sluggish few years?
Is it a plane?
Christmas is a crucial period for the travel industry. But with governments imposing increasingly stringent international travel restrictions to curb the spread of the Omicron variant, the travel and tourism sector has taken another blow. More restrictions mean more stalled planes. And shareholders have been stepping away from travel stock. Industry giants Boeing and International Airlines Group are down 16% and 15% respectively in one month. In the same period, the Rolls-Royce share price is down 19%.
But there are reasons for me to believe that Rolls-Royce can recover better than other companies operating in the air travel space. And for this, I need to look closely at what exactly the company does and where its revenue comes from.
Pros and cons
The company is focused on its power systems and defence wings to offset the uncertainties with civil aviation. And according to the latest trading update published in November, this strategy could help the company secure a positive cash flow.
The aerospace and defence company has reduced operational costs in its aircraft repair operations and has significantly grown its order book in both sustainable power generation systems and defence vehicles. The $2.6bn deal with the US government for B-52 engines for the next 30 years brings Rolls-Royce’s defence order book to £6.8bn with 70% of the orders targeted for 2022. The power systems order book stands at £2.5bn with 20% deliverable in 2022.
The firm has shed 8,000 positions in the civil aerospace division, streamlining operations to improve profits. But the net debt was still at a whopping £3.1bn in August 2021. Although the company expects to raise free cash to £1.3bn by the end of 2022, I expect debt to eat into revenue well into 2024.
And RR is currently in the midst of some incredible R&D efforts in nuclear power systems and electronic aircraft engines. These cash-intensive efforts require time to reach profitability. And I expect any further interruptions in commercial air travel to dent revenue this year and beyond. Right now, air traffic is at 50% of pre-pandemic 2019 levels. France’s travel restrictions for tourists from the UK could cause a domino effect across Europe. This could bring the industry to a temporary standstill like in 2020.
Rolls-Royce share price verdict
The future of the Rolls-Royce share price is connected to many different factors beyond the company’s control. Although the business is restructuring and looking to diversify revenue streams, civil aviation remains its biggest cash cow. And with so much uncertainty right now with travel and tourism, the share price could drop further.
And given the inflation in the UK, I expect a laboured recovery for the tourism sector. People might be reluctant to splurge given how shaky things look right now. While I think the company offers good long-term growth potential, I think I will wait and figure out where Omicron take us before investing in Rolls-Royce.
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Suraj Radhakrishnan 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.
