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Rolls-Royce Stock Tumbles as Jet Engine Maker Warns on $2.7 Billion Cash Outflow Amid New Covid Strains

Jet engine manufacturer Rolls-Royce has cut its 2021 forecasts.

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Shares in Rolls-Royce plunged more than 9% on Tuesday, after the jet engine maker warned of a £2 billion ($2.7 billion) cash outflow as increased travel restrictions aimed at preventing more contagious strains of coronavirus delay the recovery in global aviation.

The back story. Governments from Europe to the U.S. have tightened travel restrictions to slow the spread of more contagious coronavirus strains that have emerged in recent months, such as those identified in the U.K., Brazil and South Africa.

This has led airlines to cut back on flight schedules, impacting companies like Rolls-Royce, which generate service revenue based on the amount of time planes equipped with its engines are in the air.

Last week, European plane maker Airbus said it is increasing production of its single-aisle A320 passenger jets at a slower rate than the originally-expected figure of 47 aircraft.

Rolls-Royce raised about £5 billion ($6.4 billion) in funds in October last year through a rights issue and new credit lines to bolster its finances.

Read:Rolls-Royce Seeks $6.4 Billion to Bolster Its Struggling Balance Sheet. Its Stock Falls to 16-Year Lows.

What’s new. Rolls-Royce said in a trading update on Tuesday that it expects engine flying hours to be only about 55% of pre-pandemic levels this year, compared with a base forecast of 70% that Rolls-Royce gave in October.

The reduction in flying hours means that Rolls-Royce expects to see an increased cash outflow of £2 billion in 2021, higher than current analyst estimates, which range from £1 billion to £1.5 billion.

The FTSE 100 listed group generates profits through long-term contracts under which it is paid for the number of hours its engines spend in the air.

Shares in Rolls-Royce, which have fallen by almost 60% during the past 12 months, dropped more than 9% in early morning London trading before recovering to trade 4.56% lower.

The company said that continued progress on vaccination programs is “encouraging” for the medium-term recovery of air traffic and economic activity. But it warned that in the near-term, more contagious variants of the virus are creating additional uncertainty as airlines cut back schedules.

“Enhanced restrictions are delaying the recovery of long-haul travel over the coming months compared with our prior expectations, placing further financial pressure on our customers and the wider aviation industry, all of which are impacting our own cash flows in 2021,” the group said in a statement to the London Stock Exchange.

Rolls-Royce has already pledged to make disposals of about £2 billion by February next year. At the start of the Covid-19 pandemic, the group announced plans to cut 9,000 job cuts as part of plans to save £1.3 billion annually by 2022.

“This restructuring will be a key enabler of our target to deliver at least £750m of free cash flow (excluding disposals) as early as 2022, contingent on the expected recovery in engine flying hours,” the group said on Tuesday.

Looking ahead.The gloomy forecast from Rolls-Royce is a blow to investors, coming just a few weeks after the group revised its expectations for cash outflows in December from £4 billion to £4.2 billion.

Read:Rolls-Royce Will Bleed More Cash This Year After a Covid-19 Surge Stalled Its Recovery. The Stock Is Diving.

However, the company is well advanced with its cost-cutting program and liquidity—which currently stands at £9 billion—isn’t currently a worry, AJ Bell investment director Russ Mould said in a research note to clients on Tuesday, adding that should provide some comfort that it can weather the current storm.

Investors will be keeping a close eye on the state of the aviation industry and whether the second half of 2021 is realistic for a notable increase in the number of planes flying. “That matters for Rolls-Royce as its real money is made from repair and maintenance work rather than the sale of engines, and that requires planes to be in the sky,” Mould added.

Analysts at UBS said that domestic and intraregional traffic is set to benefit the most in the near-term, while long haul and wide-body engines should recover in 2023, and remain below 2019 levels until 2025. That will only increase pressure on Rolls-Royce management to accelerate its plans to sell assets and further shore up its balance sheet as it prepares for more turbulence ahead.

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