Is it boom or bust time for Rolls-Royce shares?

Jon Smith explains both sides of the outlook for Rolls-Royce shares and offers his personal opinion on which he prefers.

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The Rolls-Royce (LSE:RR) share price has dipped in and out of penny stock status since the pandemic hit in 2020. At the moment, Rolls-Royce shares trade at 93.5p, down 16.5% over the past year. This has been seen as a critical year for the business, as we finally come out of the pandemic and have some business normality. I have been considering buying the stock — so is now the time for me to get involved?

The case for booming success

One of the reasons why Rolls-Royce shares struggled historically is due to poor cash flow and high debt. Actions that have been taken recently give me optimism that this liquidity management is rapidly improving.

From one angle, the business is cutting costs. For example, the Civil Aerospace division has implemented a large restructuring, noted in a recent investor presentation. The operating cost base has been reduced by 35% when comparing the 2019 figure to the most recent 2021 one. Headcount has also been reduced by 8,700 (34%) to provide a more streamlined and efficient model.

Four asset disposals are also expected to generate around £2bn in cash proceeds this year. When I add on the secured £4.5bn of undrawn facilities from different banks, I’m much more confident in the liquidity position of the business this year.

How does this translate to performance for Rolls-Royce shares? Firstly, the share price should lift as investors become more comfortable that the business isn’t going to default. Secondly, cutting costs should ultimately help to increase profitability. Again, this should provide more optimism around Rolls-Royce shares.

Why Rolls-Royce shares could slump lower

Even though the company has divisions including Defence, Power Systems, and Electrical, the Civil Aerospace part is the largest. It’s also the area that has seen profits fall the most during the pandemic.

My concern is that the damage done in this division now means that it’ll never be able to fully recover. A large part of its success is linked to flying hours of the major airline operators. Yet the shares of these companies are also still struggling. For example, International Consolidated Airlines Group shares are close to hitting a fresh 52-week low. This tells me that investors aren’t convinced about a summer bounce back in travel demand.

Without a pickup in this area, I really struggle to see Rolls-Royce shares heading anywhere but lower. The first level to watch would be the year-to-date lows of 77p.

Given the improvement in liquidity, I don’t think that there’s a risk of Rolls-Royce going bust anytime soon. So I think the real question is whether the stock will either grind lower or seriously move higher this year.

The half-year results at the beginning of August should give me a much better indication on this. With the information I have at the moment, my bias is more towards a share price move higher. However, I don’t envision a real kick-start to a major rally happening until we get fresh information in August. On that basis, I’m looking to buy a small amount of Rolls-Royce shares now, but holding spare cash ready for later this summer.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Jon Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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