Image source: Rolls-Royce plc
Back in the day – five years ago – one thing was attractive to own Rolls-Royce (LSE: RR) shares have been a gain for aeronautical engineers. Rolls-Royce shares were destroyed during the violence and have not returned.
Despite that, the stock has performed well, rising 48 percent over the past five years. In the last year alone, the share price has increased by 182%.
Rolls-Royce's division history was uneven even before the pandemic.
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The lack of payment in recent years can be attributed to several reasons. The first was the huge losses and mounting debts after the start of the pandemic. The dividend was not a priority as the company focused on restoring financial health.
But the current chief executive also appeared to be less focused on the allocation of funds when starting the role. It deserves little or no mention in company results announcements.
Both aspects have now changed. Rolls' financial performance has improved significantly, with management setting ambitious medium-term targets that could equate to further improvement from current levels.
The company has now laid out its plan when it comes to bringing back Rolls-Royce shares: “Once we are comfortable within the investment grade profile and the strength of our balance sheet is confirmed, we intend to restore and increase distributions to shareholders..”
Chances are the payment will be returned
How long does it take for a company to be “comfortably within the investment grade profile” is subjective.
But with S&P after returning the investment grade rating of Rolls this year, I think the criterion can be met in the next few years.
What about the balance sheet?
Total debt has been trending in the right direction recently, as the chart below shows. I expect that to continue as the company's free cash flow has improved significantly.
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Even so, the total debt remains higher than where it used to stand in the years leading up to the pandemic. So I think it may take several years for the company to feel confident that the strength of its balance sheet “confirmed“.
Great potential for free cash flow
Therefore, I do not expect a dividend for Rolls-Royce in 2024 and I would be surprised if there is one in 2025 although it is possible.
I think the payment may return in 2026 or thereabouts, unless business performance changes. That could be due to reasons beyond Rolls' control, such as another sudden drop in demand for civil aviation. That is why at the current share price I am not investing.
How much is that profit? Past performance is not necessarily an indicator of future performance. I expect that the company may want to start any budget recovery in the form of savings.
In the 2027 timeline, Rolls forecasts free cash flow of £2.8bn — £3.1bn. At the lower end and assuming no further dividend from today, that would mean around 33p per share in free cash flow.
That could comfortably support dividends of 15p-20p per share, which equates to a 3.4%-4.5% return on the current share price.
With a strong product, a large customer base and improved performance are still possible. Whether it happens remains to be seen.
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