2023 has started well for Rolls-Royce (LSE: RR). Yesterday, its shares moved up 6% and got tantalisingly close to the £1 mark.
But they are still 22% lower than they were a year ago. I invested in the company last year. Despite the move downwards over the past 12 months, I continue to believe in the investment case and will hold my shares. Here is why.
Improving business outlook
The share price fell last year – but the business performance was improving on some fronts. In the first half of 2022, for example, revenues grew 9% compared to the same period the prior year.
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At the earnings level though, it was a different story. A profit of £394m in the first half in 2021 was replaced by a £1.6bn loss at the same stage last year. While the company made a loss, it sharply cut its free cash outflow, which I see as an important step for improving its long-term financial health.
During the year, Rolls-Royce used the proceeds of asset sales to help repay debts. That should improve its balance sheet. Flying hours for large engine aircraft continued to increase across 2022. The business also reported solid performances in areas beyond civil aviation, including the power systems and defence divisions.
Falling Rolls-Royce share price
But if the broad picture, aside from earnings, was one of recovery, then why did the shares fall almost a fifth last year?
Earnings matter to investors as ultimately successful long-term investment almost always relies on a company making a profit. But I think the main reason Rolls-Royce shares fared poorly last year was that investors went into the year hoping for a recovery in aviation demand that would boost the company’s fortunes. While aviation demand has indeed recovered, it remains a gradual process.
Between July and October, for example, large engine flying hours remained 35% below the pre-pandemic 2019 levels. Basically, I think investor expectations at the start of 2022 were too optimistic.
On top of that, as a company that has a large international customer base, the falling pound did not help Rolls-Royce.
Will 2023 be better?
So why have I hung onto my Rolls-Royce shares? Since buying them I have not received any dividends, although under the terms of its borrowings, that could change this year as the firm will be able to pay dividends again if it meets certain conditions.
But the main reason I am holding Rolls-Royce shares is because of what I see as the long-term growth prospects. The firm is one of only a small number of companies that have the technology and expertise to make large aircraft engines. It has an installed base of thousands of engines that can help generate servicing revenues for decades.
As aviation demand continues to recover, I expect the company’s profitability to improve. Risks remain, including debt servicing eating into profits and demand recovery stalling.
But I continue to believe in the long-term investment case and will keep holding my Rolls-Royce shares.
