Rolls Royce share price set to fall further after £1.5bn rights issue

Rolls Royce has seen its share price tumble this week and it could fall further in the months ahead after announcing plans to raise £1.5 billion via a rights issue in order to shore up its balance sheet and offset its aviation slump.

The rights issue is set to take place in September, according to reports, with the British engine maker selling new shares, diluting existing shareholders in the process, which will likely drive down the stock price further.

Rolls Royce is looking to raise additional funds to offset the economic impact of the coronavirus pandemic on the aviation industry, which it supplies and maintains engines on their behalf.

However, the disruption to flights has signifcantly hurt the profitability of its aviation arm and forced it to cut 9000 jobs in an effort to save cash amid such uncertain times.

As part of its cost-cutting measures, Rolls Royce is also looking to offload its Spanish aerospace division ITP Aero, which makes components for the Eurofighter Typhoon jet, with the unit valued at approximately £1 billion.

Rolls Royce is trading 4% lower on Thursday at 243p per share at the time of publication, with the stock down 64% year-to-date.

Rolls Royce dealt blow after ‘junk’ credit rating downgrade from Moody’s

The decision to raise additional funds via a rights issue rather than increasing the size of its debt pile could be down to the engine maker recently having its credit rating downgraded to ‘junk’ status by Moody’s – a move that will increase the cost of borrowing for Rolls Royce.

A spokesperson for Rolls Royce admitted that the downgrade by the ratings agency was ‘disappointing’, but noted that: ‘None of our borrowing facilities contain covenants or credit rating triggers that demand early repayment, nor do any of our contracts with airlines. Our current financial position and liquidity remain strong.'

Rolls Royce CEO Warren East has described the Covid-19 pandemic as the company’s ‘darkest hour’ since the 1970s when the it was forced to be nationalised after going bust.

Citigroup believes Rolls Royce shares could double in value in 2020

Earlier this month, Citigroup analysts offered an highly optimistic outlook for Rolls Royce, with the US-based investment bank reiterating its ‘buy’ rating for the stock and issuing a target price of 564p – implying a potential upside of 132%.

However, based on the uphill battle ahead of Rolls Royce and the level of uncertainty among investors due a myriad of macroeconomic headwinds, chief among them the threat of a second wave of Covid-19 cases, such a meteoric rise appears unlikely.

It is also worth noting that the stock has struggled to break above 398p since the Covid-19 crisis occurred. But if it were capable of breaking above that key resistance level this year it could push on to higher highs in the latter half of the year – though that is highly dependent on whether Europe is hit by a second wave of cases.

Rolls Royce spends £3 billion in H1 due to Covid-19

Another factor weighing heavily on the engineering company’s share price is that it spent £3 billion in cash over the first half of 2020 as a result of the ‘historic shock’ caused by Covid-19.

Rolls Royce is hoping that its performance over the second half of the year will go some way to offset the impact the viral outbreak has had on its business, with the company forecast to generate annual free cash outflow of £4 billion. Free cash flow in the six months to the end of June was hit by £1.1 billion less inflow from lower receipts linked to engine flying hours and lower engine deliveries.

‘The Covid-19 pandemic has created a historic shock in civil aviation which will take several years to recover,’ Rolls Royce CEO Warren East said. ‘We started this year with positive momentum and strong liquidity and acted swiftly to conserve cash and cut costs to protect Rolls-Royce during the pandemic.’

Rolls Royce is hoping its £4 billion of free cash outflow in 2020 will come from spending cuts and a recovery in commercial airlines now that lockdown restrictions are being eased by governments in Europe.

However, Russ Mould, investment director at AJ Bell, expressed serious concern about the health of its balance sheet.

‘Cash, the very lifeblood of any business, [is] draining away alarmingly in the first half of the year,' he said. ’The numbers are stark and will do little to stem recent speculation that the company might need to issue shares or even offload a part of the group to generate cash.’

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