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Aerospace and defence companies or exchange-traded funds (ETFs) appeal to many buy-and-hold investors. Therefore, today we discuss FTSE 100 member jet-engine manufacturer Rolls-Royce Holdings (LON:RR) (OTC:RYCEY), which announced full-year results on Mar. 11.
In the past 12 months, RR stock has declined more than 40%. However, since the start of 2021, shares have had a significant run-up and have so far returned more than 10%. On Mar. 11, they closed at 113.8p ($1.53 for US-based stock).
The company's beginnings go back to 1906. Car enthusiasts will recognize the quintessentially British luxury brand. However, fewer people might realize that during World War I, Rolls-Royce also became an aero-engine manufacturer. In the 1970s, financial woes led the company to be split into two separate entities, namely, cars and aero-engines.
In 1998, Bayerische Motoren Werke AG (DE:BMWG) (OTC:BMWYY), the Germany-based automaker known as BMW, acquired the car group, Rolls-Royce Motors. The other entity, Rolls-Royce Holdings PLC, the aero-engine manufacturer, is the FTSE 100 member we are looking at today.
The aerospace segment includes both military and commercial aircraft. COVID-19 has meant a significant hit for the civilian segment of aerospace businesses. Metrics from the International Civil Aviation Organization (ICAO) show, "as seating capacity fell by around 50 per cent last year, that left just 1.8 billion passengers taking flights through 2020, compared with around 4.5 billion in 2019."
Airlines as well as companies like Boeing (NYSE:BA) and Rolls-Royce have been affected. Their revenues and earnings have been mixed at best. However, despite its woes, BA stock is up about 35% in the past 12 months and hit a new 52-week high on Mar. 11.
Similarly, the Dow Jones Airlines index is also up about 28% over the past year. Also, the Dow Jones Aerospace & Defense index has returned more than 32% in the same period. Put another way, RR shares have not fully participated in the gains made by industry peers in the past year.
On the other hand, most nations usually have no shortage of defence budgets, providing tailwinds for many A&D businesses. At present, the US has the largest military budget, followed by China, India, Germany and the UK.
Aero-engines manufactured by Rolls-Royce are found not just in military and civil aircraft but also in other industries. For example, its subsidiary in Bergen, Norway, supplies medium-speed engines for power generation applications for the oil, gas and marine industries.
The company also offers specialized products, engineering services and safety-critical systems for nuclear power stations. In fact, most revenues come from engine service contracts that last for years following the sale of an engine. In pre-pandemic times, investors appreciated the steady stream of cash flow provided by such lucrative contracts. However, as engines stopped working, so did the income.
Full-year 2020 figures showed the adverse effect of the pandemic on operations and metrics as well as the near-term outlook. Revenue was £11.76 billion (or $16.42 billion), down close to 23.9% year-on-year (YoY). Pre-tax loss came in at £4 billion (or $5.6 billion).
During 2020, management's focus has been on achieving cost savings, some of which came from significant job cuts. It also raised money from a rights issue. It hopes to turn cash flow positive in the second half of 2021.
Bottom Line
Rolls-Royce is an important member of the FTSE 100 index and a globally-recognized name in A&D. However, it may be several months before the shares reach their pre-pandemic levels.
Given the reality that most commercial flights globally are still on hold, Rolls-Royce might not be immune to further turbulence in the air. The company hopes the flying hours in 2021 will increase to around 55% of 2019 levels. In 2020, it was 43%.
However, if that projection does not hold true, RR investors might simply decide to take money off the table. We'd look to buy RR stock if there is a decline of about 7% from the current levels.
Finally, readers looking for investment opportunities in the industry could also consider exchange-traded funds (ETFs). They include:
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