Of course, it does look nice when you trade stocks under a tenner and have Rolls-Royce shares in your portfolio. This stock with its prestigious name meets our criterion of being a true penny stock. We buy 2,000 shares for our portfolio at the current price of about 97 pence, which converts to €1.16 per share.

Despite the fact that Rolls-Royce generates almost a third of its sales in the defense sector, the stock did anything but well on the London Stock Exchange. In fact, after months of speculation about its financial situation, its share price reached its lowest level in 16 years last September. The trigger for that fall in share price was the announcement that the motor manufacturer had confirmed that it was considering a rights issue of up to £2.5 billion, which incidentally has not yet taken place due to the low share price. Analysts believe that Rolls-Royce’s balance sheet does not need immediate financing unless it is to make new, large investments and/or acquisitions. In response to takeover rumors, the share price recently rebounded sharply for a while. However, investors quickly realized that the golden share held by the British state would stand in the way of an unwanted takeover, so the share price sank again.

Profile

Of course, we all know the Rolls-Royce brand name because of its luxury cars, but it may not be known to everyone that this company has long been owned by the German company BWM. Rolls-Royce Holdings plc was founded in 1884 and is headquartered in London.

Rolls-Royce has divided its business into four divisions: Civil Aerospace, Energy Systems, Defense and New Markets. The Civil Aerospace division develops, manufactures and markets aircraft engines for large commercial aircraft, regional jets and business aviation aircraft. The Power Systems division is active in the development, production, marketing and sales of integrated power supply and propulsion solutions for marine, defense and a number of industrial sectors. Defense supplies aircraft engines for military transport, as well as patrol aircraft and marine engines. The New Markets Division develops, manufactures and markets small modular reactors and new electrical power solutions, as well as offering maintenance, repair and overhaul services.

The New Markets division could play an important role in the energy transition. Indeed, Rolls-Royce wants to accelerate the launch of a new generation of mini-nuclear reactors, a desire that has gained momentum due to the energy crisis. The company’s first mini-nuclear reactors are not expected to be ready for use until the early 2030s, but management is keen to accelerate their development as the West seeks to get rid of Russian fossil fuels following the invasion of Ukraine. Engineers at the company are said to be frustrated with the British government’s approach to nuclear power, as the approval process for reactors is unnecessarily slow. Rolls-Royce wants to build reactors capable of producing about 470 megawatts of power. That is only a seventh of the energy generated by the large, new reactors, but on the other hand, the cost is only about a twelfth. The government in London argues that Rolls-Royce’s product is new and thus must undergo thorough safety checks. However, Rolls-Royce engineers have repeatedly pointed out that their company’s technology is based on the know-how gained from the development of nuclear-powered submarines, a technology that has already been thoroughly tested.

Rolls-Royce cannot actually be acquired without the consent of the British government. This is because the government holds what is known as a golden share, which is the name for a special veto right held by a specific shareholder. A golden share generally has no voting rights, but gives the holder, the minister or other person acting on behalf of the government, the right to attend and speak at general meetings. It does not give a right to participate in the capital or share in the company’s profits, but it does provide a blocking right in special situations such as a takeover bid.

Figures

Britain’s best-known engineering firm was hit hard by the covid-19 pandemic as airlines pay Rolls-Royce based on the number of hours the company’s supplied engines actually fly. Therefore, due to the exceptional circumstances caused by the pandemic, the 2021 fiscal year cannot be considered a measure of Rolls-Royce’s performance. Incidentally, the same applies to fiscal year 2020. In 2021, Rolls-Royce generated £414 million in underlying operating profit, compared with a loss in the previous year. The growth recorded in the Power Systems and Defense divisions contributed to a substantial improvement in financial performance. By 2021, free cash outflow from continuing operations was £1.5 billion. CEO Warren East commented on the figures, “We have improved our financial performance, met our near-term commitments, secured new, business opportunities and made significant strategic moves during the year. While challenges remain, we can look to the future and the significant commercial opportunities presented by the transition to the energy transition with increasing confidence.”
Because Rolls-Royce’s credit profile has improved since the pandemic outbreak and there is limited exposure to the conflict between Russia and Ukraine, ratings agency Moody’s adjusted its outlook from negative to stable.

Pros:
– Good predictability of results.
– Margins in the defense division are holding up well.
– New CEO Warren East wants to bring a breath of fresh air to the company.

Contras:
– Loss of market share in business jet division.
– Evolution of cash flow disappointing.
– Development of new engines costs handsomely.

Conclusion

We are not too enthusiastic about this stock. There is no shortage of good intentions on the part of management, but they are not translating into better results as yet. The company focuses on too many markets and you cannot be the best in everything. Rolls-Royce would therefore do well to focus on a few core activities and divest all non-core businesses. For example, the future does not look very good for the business jets division, and that was true even before the outbreak of the energy crisis. Perhaps selling this division is a good solution, especially now that a good price can still be asked for it. Rolls-Royce’s management stated in August 2021 that it may want to sell turbine blade maker ITP Aero and other assets to raise at least £2 billion.

Worldwide, there are 20 analysts who follow Rolls-Royce stock and they believe that a 28% share price increase is possible within a 12-18 month time frame. The analysts at SharesUnion think that the share price has pretty much bottomed out. We therefore take the opportunity by buying the stock. Needless to say, we are keeping our finger on the pulse.

A takeover need not be counted on under current circumstances. Rolls-Royce is a major player in the defense sector and the British government will not hesitate to use its golden share in preventing an unwanted takeover. Moreover, ceding control of Rolls-Royce’s expertise in modular nuclear reactors is inconsistent with the government’s plans. Prime Minister Boris Johnson is a strong supporter of nuclear power and he undoubtedly wants to keep the nuclear know-how at home, something that is very understandable in light of the current energy crisis. By the way, rumors of mergers and acquisitions have been circulating for some time. For example, the company was already the subject of takeover speculation in both 2015 and 2020. After a series of profit warnings in 2015, the share price fell by about 75% and its recovery has been difficult to say the least.

We would like to draw investors’ attention to the fact that Rolls-Royce realized 31% of its revenues last year with its defense segment. We also see much in the development of small, modular reactors within the New Markets business. These will not generate significant revenue in the short term, but offer a significant growth opportunity in the longer term. In our view, CEO Warren is doing everything he can to make Rolls-Royce successful. The one-year chart below shows that Rolls-Royce shares experienced fierce share price gains, but now that the price has fallen 10% again in recent weeks, we are taking the opportunity and buying 2,000 shares of Rolls-Royce in the portfolio of SharesUnder Ten.

Fundamentals Rolls-Royce Holdings Plc
ISIN Code: GB00B63H8491
Ticker symbol: RR.L
Stock Exchange: London Stock Exchange
Earnings per share 2021: £0.12
Tax. earnings per share 2021: £0.62
Tax. earnings per share 2022: £4.62
P/E ratio 2020: 8
Based on share price of: 99.37 pence
Share price high last 12 months: 161.91 pence
Share price low last 12 months: 83.49 pence
Dividend: –
Dividend yield: –
Number of shares outstanding: 8.37 million
Market capitalization: £8.32 billion
Sector: Technology
Return on assets: 1%
Return on equity: –