Rolls-Royce (LSE: RR) shares have been on a dismal run this year. But things are looking brighter for the engineering firm with recent developments shining a light on some of its recent projects. While its core business gathers momentum with the return of air travel, its emerging businesses look like they could be great future cash generators. Can the Rolls-Royce share price finally gather enough momentum to make a rebound from here? Here are reasons why I think it is very likely.
Are Rolls-Royce shares ready for takeoff?
The board describes 2021 as a period of transition and this is true in more ways than one. Yes, the company made considerable inroads in its power systems and defence wings. But the strongest sign that Rolls-Royce shares could make a comeback is the rise in civil aviation numbers.
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Aircraft transition data is a good way to judge the health of the aviation industry. A transition is when an aircraft is repurposed (commercial to cargo) or traded with another firm. Transitions usually mean new service and maintenance contracts, which is a huge market for Rolls-Royce. And transition activity increased in 2021 after a dull 2020.
In 2021, 83% of grounded aircraft re-entered service and 177 transitions were completed compared to 94 in 2020. And a large chunk of the transitioned flights has Rolls-Royce’s Trent 700 engine. The company expects a 200% jump in CareStore service agreements and fleet contracts in 2022.
Although this alone will not boost Rolls-Royce shares, it is a positive development that could improve earnings in the upcoming 2022 half-year results, expected on 4 August.
Perfect new markets
I think Rolls-Royce’s decision to funnel resources into power systems and defence in the absence of air travel was a great business decision. Both sectors are under the spotlight after the Russian invasion of Ukraine.
Defence budgets are increasing at record levels. The world military expenditure crossed US$2trn for the first time in history this year. And Rolls-Royce’s huge defence order book is a great sign for the business. The company recently signed a £105m contract with the UK government to support its Hawk jet fleet. It also won a contract, alongside BAE Systems, worth over £2bn to improve UK’s nuclear deterrent program amid heightened tensions in the region.
The crude oil crisis has put European renewable energy asset exploration and development into overdrive. And this directly benefits Rolls-Royce’s small nuclear reactor project. Current estimates say the first reactor would enter the power grid by 2029.
My concerns and verdict
These are all huge positives for the company. And defence and energy sectors would largely remain unaffected by a recession, given their importance. But, Rolls-Royce shares do come with some red flags as well. The £5.1bn debt could increase considerably if travel recovery is stalled due to a recession. And Rolls-Royce shares look expensive, despite the 33% decline in 2022, trading at a price-to-earnings ratio of 57 times.
But I think Rolls-Royce, currently trading as a penny stock, is a great growth option for my portfolio. The company has used its downtime to restructure well and is now an exciting business with a lot of new projects over the next decade. I will wait to judge investor reaction to the half-yearly report in August before making an investment.
