2021-02

# Rolls Royce Stock Analysis

Rolls Royce is near an all time low, and I wondered if it was a good long term investment. Here is my analysis. Of course, none of this is financial advise! Last week I started this topic on Reddit. Based on the sentiment on Reddit, this is what I heard: 1. Do not confuse Rolls Royce with the car company. Auto manufacturing unit is now owned by BMW. 2. Rolls Royce is primarily an aerospace, aviation and defense company. 3. People generally do not expect a short-term recovery in aviation. 4. Others see the all-time-low stock and are willing to throw some money on it.

## Current Scenario

Rolls Royce has been hit by the "double whammy" - aviation distress due to Covid-19 + the Brexit drama. Which resulted in the stock price hovering around £1 since late October. Pre-Covid price was hovering around £7.

## Fundamentals

The company has cash reserves of £9 billion and they expect to burn £2 billion this year. This projection is based on expectation that air-traffic in 2021 will be 55% of 2019. Here's the revenue breakdown (as per 2019 annual report) * Civil aerospace 51% * Power systems 22% * Defence 21% * ITP Aero 6% * Others 1% Out of these, in 2019, Defence was the most profitable business unit, despite accounting for one fifth of the revenue. Civil aerospace was the least profitable with an operating profit just under £50 million. Their 2019 backorders were £61 billion, thus appearing to be in firmer financial footing than what the stock price indicates.

## FY20 Estimates and FY21 and FY22 Projections

FY20 Loss (£1682mil) *estimate FY21 Profit £209mil *projection FY22 Profit £790mil *projection While the exact numbers in these estimates and projection might differ, analyst consensus expects a strong Rolls Royce recovery in FY22 starting with a partial recovery in FY21.

## Rolls Royce and the Indian Defense Sector

From recent press releases, two items caught my attention. First was their partnership with HAL (Hindustan Aeronautics Limited) regarding the production and supply chain of Adour Mk 871 and Trent engines. And second was their partnership with Infosys for Aerospace Engineering in India. Why these reports excite me: 1. One obvious reason is the operational efficiencies to be gained from moving production to India. 2. India is one of the largest defense markets in the world and HAL recently won a contract with the Indian air force for the delivery of fighter jets and trainers. 3. Companies that move manufacturing to India tend to win larger Indian defense contracts, as seen with Dassault Aviation's recent success in this market. There's another likelihood. India's indigenous aerospace sector has made rapid progress in the last two decades. But one of their achilles heels has been the ability to produce engines and propulsion systems. Groups like Tata, Infosys, Reliance are eager to capture the Indian defence and aerospace market. With Rolls Royce's proven propulsion system capabilities and their all-time low stock price, one can't rule out enhanced interest in partnerships, mergers and acquisitions. This won't be the first time an Indian conglomerate has shown interest in British industrial assets.

## Scenario 1: Steady Recovery

The first scenario is in line with analyst projections of profitability in FY21 and FY22. This will see a steady increase of the Rolls Royce stock price to par value at £7-£10 in the next two years. Just a return to pre-Covid levels yield 5x to 7x returns. Ask yourself how soon would Rolls Royce recover to post-Covid levels.

## Scenario 2: Acquisition

Second scenario is the stock price struggling due to Covid and Brexit in the first half of 2021, which then leads to an increased acquisition interest in Rolls Royce by either American or Indian defense / aerospace companies. It is hard to predict stock price in this scenario, but it will be magnitudes greater than current price of £1.

## Scenario 3: Status Quo

Covid could get worse. Brexit drama continues. Rolls Royce's civil aerospace business struggles and is potentially sold off. The stock price witnesses a marginal recovery in this scenario, let's say in the £2.5 range sometime in 2022? Still a 2.5x return in 18 to 24 months.

## References

- Trading Update January 26th 2021 rolls-royce.com - 2019 Annual Report rolls-royce.com - February 12th 2021 Analyst Consensus rolls-royce.com - HAL Wins IAF LCA-Tejas Order financialexpress.com

## Disclosure

With these current prices and the obvious opportunity, this author might throw all available spare change and grab as much of the Rolls Royce stock he can under £2. I'm not advising you either way.