Shareholders in Rolls-Royce (LSE: RR) have experienced considerable turbulence lately. It’s not all bad: the Rolls-Royce share price is up 21% over the past six months. But over the past year, the shares slid 7% — and that excludes their dramatic loss of altitude last March.
Aviation is now showing signs of recovery. So could the share price also recover in the second half of 2021?
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One of the key factors dragging down the share price has been the reduced number of flying hours for many engines serviced by the company. That translates into reduced revenues and profits for the engineering giant.
I previously explained the importance of flying hours to the company’s business model. Initially many commentators were optimistic that mass vaccination would lead to flying hours returning closer to normal in the current half.
This is happening in some markets – for example, the US carrier American Airlines announced last week that it expects to fly over 90% of its domestic seat capacity this summer compared to its 2019 levels. Even on its international routes, the American flag carrier forecasts flying 80% of it 2019 capacity.
European demand could hamper the Rolls-Royce share price
But in Europe, demand recovery is slower and this is a key risk for the share price as it translates to lower profits. I don’t see a chance of a recovery in Europe quite at the American level until the second half of the year.
But there are signs that the recovery could come fast when it does happen. Ryanair boss Michael O’Leary has said he expects some families to be taking European holidays from the middle of June, and he forecasts a strong profit recovery for Ryanair next year.
That should be positive news for the Rolls-Royce share price. Rolls’ modelling suggests that across this year overall, large engine flying hours will be able to climb back to 70% of 2019 levels. The American example gives more credibility to this estimate in my view.
Rolls-Royce has made strenuous efforts to improve liquidity.
In its most recent annual report, liquidity stood at £9.0bn, up from £6.9bn the prior year. So I don’t worry about its liquidity for now. However, some of that liquidity came through a rights issue, which diluted shareholders. There is a risk that if liquidity is weak in future, shareholders could again face similar dilution.
Free cash flow positivity
Despite its strong liquidity, turning free-cash-flow-positive would still be good news for the company. It would suggest some tangible business recovery. The company could start adding to its cash pile instead of depleting it.
The company still expects negative cash flow for 2021 overall.
But crucially, it expects to turn free-cash-flow-positive in the second half of 2021. I think increased flying hours make that target look plausible. If the company achieves this, I expect it to be a boost to the Rolls-Royce share price. On that basis, I do think the price could show some recovery and could increase in the second half of 2021 compared to today’s level.
Clearly, though, there is a risk that returning to positive free cash flow will be delayed, for example by further lockdowns or a slower return of flying demand than forecast.