Rolls-Royce's Struggles Continue, Survival in Question

Rolls-Royce stock fell to multi-year lows this year amid the sell-off in cyclical industries. The aviation industry has been impacted severely by the COVID-19 pandemic. The financial troubles at airline companies have trickled down to aircraft manufacturers like Boeing and also companies like Rolls-Royce that supplies engines for aircraft. Will Rolls-Royce survive the COVID-19 pandemic?

The troubles in the aviation sector have also hit Berkshire Hathaway’s portfolio. In April, Warren Buffett sold all of the four airline companies that Berkshire Hathaway was holding. In the second quarter, the company took almost a $10 billion writedown on its investment in Precision Castparts, which it acquired in 2016.

Rolls-Royce has a long history of being nationalized and getting privatized. The company was nationalized by the UK government in 1971 following a bankruptcy. However, Rolls-Royce privatized again in 1987. Currently, it's a publicly-traded company listed on the London Stock Exchange. The stock also trades on the OTC markets.

Causeway Capital Management is Rolls-Royce’s largest shareholder holding 7.5 percent of its shares, while Vanguard holds a 5.7 percent stake in the company. Harris Associates is the third-largest shareholder with around a 5 percent stake.

The iconic Rolls-Royce cars are made by BMW and not Rolls-Royce Plc. BMW took responsibility for Rolls-Royce cars in 2003. Many analysts have been calling on BMW to spin-off Rolls-Royce cars in a bid to unlock value. While BMW owns the Rolls-Royce car brand, it's different from Rolls-Royce Plc, which is mainly into civil aviation, defense, and power systems.

The COVID-19 pandemic has taken a toll on Rolls-Royce. The company’s revenues in the first half of 2020 fell by 24 percent YoY, while its underlying net loss was almost $4.5 billion during that period. While the losses included a one-time write-off and losses on its forex hedges, it’s still a substantial loss for the company. Rolls-Royce's market capitalization is only about $13 billion.

Even before the COVID-19 pandemic, Rolls-Royce faced issues with some of its engines. The stock is still trading below its 2013 highs. The stock couldn't reach those price levels even before the COVID-19 pandemic started. The coronavirus pandemic made things worse because the demand for wide-body planes fell sharply. Rolls-Royce produces engines for wide-body aircraft. Now, the company is reportedly thinking about entering the engine market for narrow engine body aircraft as well.

Rolls-Royce has taken a flurry of measures to survive the COVID-19 pandemic. The company is restructuring its business and exiting some of the non-core businesses. It's slashing costs through various measures including headcount reduction. Rolls-Royce also suspended dividends earlier this year.

Rolls-Royce has taken several measures to strengthen its balance sheet. In October, the company announced a rights issue at a massive discount to the prevailing stock price and raised $2.6 billion from the issue. It has also raised cash by issuing debt. Rolls-Royce drew from the UK government’s debt package. The company has major debt repayments coming up next year and it will need cash to service the debt. The company’s credit rating is in the junk category.

Rolls-Royce has raised enough buffer cash to survive the near-term cash burn. The global economic activity is expected to increase at a sharp pace in 2021 amid hopes of successful coronavirus vaccines. Rolls-Royce's business restructuring and cash cuts are also positive in the medium to long term.

Given the strategic nature of Rolls-Royce for the UK government, with the company contributing significantly to the country’s exports, the government might step in if necessary and help the company survive.