At the start of today’s trading session, Rolls-Royce (LSE: RR) was trading around the 100p mark. This fresh weakness left me wondering if it can stay above 100p over time.
Short-term outlook for the share price
In the short term, I think it could well fall below this level. The FTSE 100 index has had a poor start to the day. It is down by 2% as I write. As a result, the broader environment is unsupportive of an upturn in the Rolls-Royce share price.
This is particularly bad news on a day that the company released a lukewarm trading update.
Continued weakness in civil aerospace
For the January-April period, its preferred performance measure of large engine flying hours was at 40% of levels in 2019. This number was actually slightly lower than the 43% seen for 2020 as a whole compared to 2019.
Considering that more than half of Rolls-Royce’s revenue comes from its civil aerospace segment, continued weakness in flying hours is a downer. If stock markets remain weak, I think it is possible that along with weakness in other FTSE 100 stocks, the Rolls-Royce share price can tumble below 100p as well.
Recovery likely over time
But over the next year or two, I think the Rolls-Royce share price stands a good chance of recovery. The first reason I think this is based on its outlook in the rest of its trading update.
It is optimistic about its power systems and defence segments, which together contribute 40% to revenues. As far as the power systems operation goes, Rolls-Royce says that it expects “recovery to accelerate” through the rest of 2021.
On defence, it says that it “has continued to perform resiliently with high levels of backlog cover”. It is also currently awaiting the outcome of its tender to the US Department of Defense. It also mentioned increased defence spending announced by the UK government last year.
And it spoke positively of financial developments. Free cash flow is expected to turn positive in the second half of the year. It also reported cost savings of £1.3bn, which shows progress in its restructuring programme. Among other things, the programme aims to reduce its fixed cost base.
Additionally, as the global economy recovers and vaccinations proceed, stock markets can be reasonably expected to remain elevated. Also, travel restrictions will ease, which will impact Rolls-Royce’s civil aerospace business positively.
A note of caution
But, in the words of the company itself “guidance remains sensitive to the timing of EFH recovery” (EFH means engine flying hours). I think it is important to keep this in mind, because travel regulations could be in place longer than expected. Just yesterday I wrote about the extension of cruise cancellations by Carnival on pandemic concerns.
My takeaway for Rolls-Royce
All things considered though, I think the Rolls-Royce share price could sustainably recover to longer-term 100p+ levels. But right now, its situation continues to be volatile. I would wait for some more recovery in the company before buying the stock.
