Despite the pandemic being almost entirely in the rear-view mirror, the Rolls-Royce (LSE:RR) share price continues to tumble. In fact, it’s fallen by just over 42% since 2022 started.
To put that in perspective, a £1,000 investment in the stock made in January is now worth around £580. And for those who invested before the pandemic, their balance is closer to £315.
What happened? Is this a falling knife? Or should I be getting ready to add this engineering business to my portfolio at a bargain price? Let’s take a look.
The bull case
The initial tailspin of Rolls-Royce shares isn’t hard to understand. With Covid-19 decimating the civil aerospace industry, a large portion of the firm’s revenue stream became temporarily compromised, leading to a record-breaking £3.2bn loss.
Since then, the operating environment has significantly improved. In fact, looking at its latest interim results, all three of its primary divisions are performing admirably.
- Higher flying hours have pushed civil aerospace service revenue up by 16%, bringing it one step closer to the full recovery expected in 2024.
- Top-line performance of its defence segment fell by 7% due to contract timings. But Rolls-Royce completed the first milestone in its massive B-52 contract with the US Air Force.
- Demand in its power systems division has hit a new record, primarily from critical backup power solutions for data centres, growing the order intake by 53% to £2.1bn.
These improvements in underlying performance have collectively enabled free cash flow to surge by over £1.1bn in just a year, bringing it almost back into the black.
Needless to say, that’s excellent news. So, why has the Rolls-Royce share price continued to collapse?
The plummeting Rolls-Royce share price
As always with Rolls-Royce, two factors continue to have investors on edge. The first is debt and the second is net income.
Following approval for the sale of its ITP Aero business, the balance sheet is about to get flooded with around £2bn of capital. Management has already stated that this will be used to pay off a large chunk of its outstanding loans. Yet, with nearly £8bn in debt obligations, Rolls-Royce will need to do a lot more to refortify its financial position.
Regarding the bottom line, earnings for the last six months came in at a loss of £1.6bn versus a gain of £394m a year ago! What happened?
I’ve often highlighted the potential impact of unfavourable foreign exchange fluctuations. And the recent performance of the Rolls-Royce share price perfectly demonstrates how bad things can get.
Due to recent volatility in foreign exchange rates, the firm suffered a £464m profit impact. This was further exacerbated by a £1.5bn loss from a decline in the value of its forward exchange currency contracts.
While these external factors are largely out of management’s control, it does, nonetheless, add more fuel to the fire. So, I’m not surprised to see the Rolls-Royce share price tumble this year.
Is this a buying opportunity? Maybe. But there are too many unknown factors at play for tastes. Therefore, I’m not planning on adding any shares to my portfolio today.
