It’s been a challenging time for aircraft engine makers and Rolls-Royce (LSE: RR) is no exception. With the Rolls-Royce share price losing a third of its value since early December, the question some investors will be asking is: how low can it go?
Here I consider what is driving the share price lower – and where it might go next.
The Rolls-Royce share price has fallen
Although the Rolls-Royce share price has lost ground in recent months, it is almost unchanged over the past year, shedding just under 2%. That it is behind the FTSE 100 gain of 10% in that period, but it is far from terrible.
The announcement of vaccines late last year helped boost the Rolls-Royce share price. Investors anticipated travel demand increasing. Since then, the shares have fallen back to roughly where they were a year ago. That suggests the outlook now is similar to then.
But is that right?
Aviation demand is coming back
I think UK investors may be overemphasising local news when it comes to the pace of aviation recovery. In some markets, civil aviation is back with a vengeance. The world’s biggest civil aviation market is normally the US. US carrier Delta said last week domestic leisure demand is back to pre-pandemic levels.
That doesn’t mean flying is back to normal. Business demand remains subdued, and European markets are behind the US in reopening. Nonetheless, what the US shows is that once passengers can fly again, many of them will.
Other revenue streams
In addition, it’s also worth noting that civil aviation is only one of Rolls-Royce’s business areas. Admittedly it is crucial to the company. But that shouldn’t overshadow the fact that the company derives substantial income from areas such as defence and power systems. They have proven more robust during the pandemic than civil aviation.
Sentiment over facts
So, if civil aviation demand is set to recover, why has the Rolls-Royce share price continued to weaken?
Partly I think that investors have soured on the company. Tumbling revenues last year combined with a highly dilutive rights issue meant that the investment case looked weaker than before. But even before the pandemic, Rolls-Royce had been struggling to impress investors. It had issued a profit warning in 2019.
Once sentiment takes hold in the stock market, share valuations can become detached from underlying financial analysis. That’s why I think the Rolls-Royce share price could still move lower from here. Despite a lower share price and a recovering aviation market, the shares still seem to have fallen out of favour with the City.
My next move on the Rolls-Royce share price
So does that represent a buying opportunity for my portfolio?
For now, I don’t think so. The company has repeatedly said it expects to turn cash flow positive in the second half. There is a risk that if it revises that date, the shares could yet fall further. The stuttering nature of travel recovery in Europe could also continue to affect sentiment towards the shares, even if other markets return to health.
I still think the Rolls-Royce share price could move up this year. But that is not assured. The next move could be further down from here – there is nothing to stop the shares continuing to move lower.
