The emergence of the Omicron Covid-19 variant has dampened the recovery story in the Rolls-Royce share price. While the World Health Organisation has warned against travel bans, some international routes have already been restricted, potentially affecting Rolls-Royce’s jet engine business.
Given that the engineering giant only returned to profit in the first half of fiscal 2021, it remains to be seen how much of an impact the new variant could have on the Rolls-Royce share price after it releases earnings on 9 December.
During the six months to the end of June, the group posted a surprise net profit of £393m, dwarfing the £5.37bn loss reported in the first half of the previous fiscal year and beating consensus expectations.
Improving cash flow also helped the aerospace company report revenue of £5.15bn. Its civil aerospace segment, which mainly includes the servicing of jet engines, accounted for £2.16bn. Though this was down from £2.51bn in the first half of 2020, the segment swung to a gross profit of £380m from a loss of £1.55bn.
The company’s half-year results, released in August, indicated that it expected the recovery in domestic flying and business aviation to continue once restrictions were lifted. Indeed, large-engine flying hours came in at less than half of pre-pandemic levels – 43% of H1 2019. However, this was up 34% from the second half of 2020.
Rolls-Royce’s share price shows resilience
Rolls-Royce has been taking steps to restructure its business, with 8,000 roles having been removed. It expects to deliver savings of more than £1bn by the end of 2021 and plans to reduce headcount by 9,000 in total. It is also on course to deliver annualised cost savings of £1.3bn by the end of 2022.
However, as the company prepares to report its third-quarter earnings, the emergence of Omicron has potentially thrown a spanner in the works.
The Rolls-Royce share price peaked at a 52-week high of 150.48p on 9 November but has since pulled back, closing at 129.70p on 6 December. Although the stock hasn’t nosedived as much as some aviation and travel stocks have, there is a significant risk that it could get caught up in the variant storm.
Our chief markets analyst Michael Hewson believes “investors will probably need to temper their expectations somewhat”.
Rolls-Royce is positive on its defence and power systems segments, as well as its newer business areas, including plans to develop small modular nuclear reactors, for which it secured more than £400m in funding last month.
Despite a lower cost base in its civil aerospace segment, largely because of its restructuring, travel restrictions could push back the group’s goal of achieving free cash flow (FCF) of £750m even further.
What analysts want to hear from Rolls-Royce
Investors will likely want an indication as to whether the group is expecting to report another profitable half when it reports annual results early in 2022, as well as an update on its FCF target. There is, of course, the concern that the group could swing back to a loss in the second half of the year and beyond if travel restrictions are to hamper the production and servicing of long-haul engines.
Hewson comments: “International travel still looks like a headwind particularly as we head into the winter months, and governments reintroduce restrictions as a consequence of new variants.”
Hargreaves Lansdown analyst Sophie Lund-Yates suggested in a client note seen by This is Money that the civil aerospace segment’s exposure to volatile travel conditions means it could be some time yet before Rolls-Royce roars again.
“Producing and servicing aircraft engines has not been a nice business to be in over the last 18 months,” Lund-Yates wrote. “To that end, we aren’t expecting a complete about-turn in fortunes.”
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