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He Rolls-Royce holdings (LSE: RR.) share price has risen 40% in the days since full-year results. So surely we won’t see an accident in 2023, right?
I don’t think it’s likely that we will, no. But there are dangers, and investors shouldn’t just assume it’s just up here. There really could be more volatility ahead.
Just look at where we were in October 2021. Rolls-Royce’s share price had recovered to almost where it is today. But it fell more than 50% over the next 12 months.
It may not have been sudden, but it was a fall of shock proportions, for sure. Could it happen again? Yes, I think it could. Let me explain why I think that.
The problems have not gone away
Things have definitely picked up for Rolls-Royce over the last year. His problems have alleviated, clearly. But those problems certainly haven’t gone away.
Take debt, for example. Over the past year, Rolls has managed to reduce its net debt from £5.2bn to £3.3bn. That’s huge. But it was mainly financed by disposals, and those are not sustainable.
The same provisions will not be there next year. What if we don’t see enough cash generation to make up for it and the debt doesn’t fall as quickly as we hope? Well, investor sentiment can change in the blink of an eye.
debt payment
However, some aspects of Rolls’ debt situation make me optimistic. The company paid off its £2bn UK Export Finance-backed loan in September 2022, which matured until 2025. That suggests two things I really like.
One is that debt repayment is a high priority. In the same situation, I’m sure some would have held on to such a favorable loan and used the cash for other things. Maybe even paying early dividends to sweeten big-city investors.
Cash flow
It also suggests confidence in the recovery of cash flow and that the company’s operations can generate the necessary financing.
In fact, Rolls-Royce’s board expects to raise between £600m and £800m in cash flow in the current year. I find it impressive at this stage of the aero-engine maker’s turnaround.
But there is still a long way to go and investors will have to be patient. Right now, we’re seeing an exuberant reaction to the better-than-expected results. That is to be expected. And shareholders deserve a little cheer.
waiting game
But sentiment is fickle, and the waiting game might not be exciting enough. What if the cash flow recovery is below expectations? It could still be perfectly fine, but shareholders could tip over again.
I think Rolls-Royce stock will really start to look safe once progressive dividends are reintroduced and we see strong earnings coverage and a sustainable outlook.
I think that will happen, maybe even sooner than expected. And it puts the stock on my potential long-term buy list. But the danger is not over yet and I think investors should be prepared for more ups and downs.
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