After a spell of disappointing performance, could we be seeing a turnaround in the fortunes of Rolls-Royce (LSE: RR)? The Rolls-Royce share price has moved up 28% in just a few weeks, although on a one-year timeframe it has lost 37% of its value.
The aeronautical engineer’s shares continue to trade for pennies. But if the recent positive momentum carries on, I think they might hit a pound.
Solid business performance
The company updated the market on Thursday about its current trading. I think the latest news could provide further support for the Rolls-Royce share price in coming months.
The engineer maintained its guidance for the year despite growing challenges such as the impact of inflation on profit margins. The company pointed to a continued recovery across its business including a record order intake in its power division. The recent sale of a subsidiary enabled repayment of a £2bn loan years in advance. Cleaning up the balance sheet and reducing debt should help the company’s economics, so I see this as a positive development.
A key part of the investment case for Rolls-Royce is the sales and servicing revenues it can generate from its aircraft engine division. Large aircraft flying hours remain below pre-pandemic levels — they are 35% lower than in 2019. But the trend is in the right direction, with such flying hours up 35% so far in 2022. Continued recovery should be good for both revenues and profits. That could help boost the Rolls-Royce share price.
Investor confidence and the Rolls-Royce share price
But if Rolls-Royce has simply maintained its full-year guidance rather than raising it, why has the share price been increasing markedly?
I think in the current economic environment, maintaining full-year guidance is a promising sign that Rolls-Royce is doing a good job managing its cost base. That should be good for profitability.
Perhaps investors have also been reassessing the underlying investment case for Rolls-Royce on the basis of the apparent ongoing recovery in its business. As one of a small number of players in an industry with high barriers to entry, Rolls-Royce has strong pricing power. Its installed base of thousands of engines should help it generate revenues for years if not decades to come. The right cost management combined with a healthy balance sheet could see those revenues converted into chunky profits.
I’m holding
On that basis, I reckon we could indeed see the Rolls-Royce share price move above the £1-level again at some point. At today’s price, that would require a 17% increase.
The trigger for such a move could include more good news from the company or increased evidence of a recovery in global aviation demand.
Having said that, Rolls-Royce shares have lost a lot of value in the past year and they could still move downwards from here. While the firm seems to be managing inflation for now, it remains a longer-term risk to profitability. A tightening economy might hurt demand for leisure travel, which could be bad news for new engine orders.
As I already own quite a few Rolls-Royce shares, I will not buy any more for now but will hold my position. Hopefully the share price will maintain its recent run of growth!
