Is now the time to buy Rolls-Royce shares for passive income?

At Rolls-Royce (LSE:RR) share price exploded late last week after the release of exceptional trading numbers. This has led some to believe that the engineer could be the top stock to buy for passive income.

At FTSE 100 the company has not paid a dividend since before the pandemic. But City analysts expect Rolls to restart shareholders as trading conditions improve and the balance sheet strengthens.

The forward yield is not the greatest for the next two years. At the current Rolls-Royce share price of 122p per share, it yields a dividend of 0.2% and 1.1% for 2023 and 2024. But should I buy a business with strong long-term passive income potential?

Quick recap

The full-year results on Friday have boosted investors’ hopes that Rolls-Royce is on track for a strong and sustained recovery.

Over the course of 2022, underlying profits rise by 16% to £12.7bn. This was driven by a 25% jump in the Civil Aerospace division as the recovery in air travel boosted service revenues.

Rolls’ underlying profit rose to £206m last year from £36m in 2021 as a result. Free cash flow meanwhile rocketed to £505m, a big increase on the £1.5bn outflow recorded a year earlier.

Strong cash and asset outflows during the year helped net debt fall to £3.3bn in December. This is down significantly from £5.2bn a year earlier.

“sign of strength”

I have been reluctant to buy Rolls-Royce stock for a long time because of its huge debt. The huge responsibility taken during the Covid-19 crisis casts a cloud over how to finance growth projects. As an investor, I am also concerned about the impact on future dividends.

So, of course, the company’s strong improvement has eased my worries. Analyst at Hargreaves Lansdowne have commented”leaner organizations have shown signs of strength“and added”if the cash flow continues, the group will be able to continue to reduce debt, which will go a long way towards restoring our faith in Rolls’ ability to stand on its own two feet.“.

Encouragingly, Rolls predicts higher free cash flow of between £600m and £800m by 2023.

Not out of the woods

However, I have not joined the rush for Rolls-Royce shares in recent days. The business still has many challenges to overcome before a successful process is seen.

Just last month, new CEO Tufan Erginbilgic described the business as “burning platform” that underperforms competitors and has a history of creating value-destroying investments. It is according to the new Financial Times report.

There are also things that Rolls can’t control that can backfire. The recovery of the travel industry remains fragile as the global economy shrinks and Covid-19 continues in China.

Continued cost inflation and supply chain issues could also hurt profitability and further balance sheet improvements.

Hargreaves Lansdown has even suggested that it remains too early to expect the engineer to start paying back. It says that “given that Rolls still has a negative equity position – meaning liabilities are greater than assets – we are skeptical about seeing any dividends this year.”

Rolls-Royce is a FTSE 100 stock I like. But for now, I still prefer to buy more UK stocks for passive income.