After six months of turbulence, it finally looks as if Rolls-Royce (LSE: RR) shares are on the up. A series of positive trading updates have helped improve investor sentiment towards the business. And in the past few days, there’s been one significant development that could help the company pull out of its current tailspin.
Rolls-Royce share price tailwind
Rolls-Royce isn’t like most businesses. The company doesn’t make money on the engines it sells to aircraft manufacturers. Instead, the firm relies on multi-year service contracts to produce profits. It sells the machines at cost and then earns money on the lifetime service contract.
Many of these contracts are tied to the number of hours the engine flies. So a busy aircraft can produce a lot of money for the group. This also means that when an aircraft is grounded, Rolls is effectively losing money. That is just what has happened to the business this year. Coronavirus travel restrictions have grounded the planes of most major airlines, which hit the bottom line and Rolls-Royce share price.
The company has also had to deal with growing losses from the grounding of Boeing’s 737 Max. Utterly unrelated to coronavirus, regulators grounded this plane around the world after a series of serious accidents. The grounding lead to cancelled orders and rising losses for Boeing and its suppliers.
The good news is that it looks as if the plane will be allowed to start flying again. Last week, Europe’s aviation regulator said the Boeing 737 Max is safe enough to return to the skies before the end of the year. The news sent the Rolls-Royce share price surging.
The positive news on the 737 Max front isn’t the only tailwind that could help Rolls in the months ahead. A concerted effort by regulators and governments to restart international travel is also starting to yield results.
Air traffic in the United States has recovered to around 40% of pre-pandemic levels. Meanwhile, activity in Chinese airspace is closing in on 2019 levels. These figures suggest the outlook for the Rolls-Royce share price is steadily improving. More planes in the sky should translate into much-needed revenue for the group.
At the same time, the company’s efforts to bolster its balance sheet also seems to have improved investor sentiment. At the beginning of October, the group announced plans to raise £5bn from investors to strengthen its balance sheet. This removes any concerns about the organisation’s ability to continue as a going concern.
As such, it appears the outlook for the Rolls-Royce share price is steadily improving. While the company is not totally out of the woods just yet, it may be an excellent time to buy a share of the business as part of a diversified portfolio as its recovery gets underway. Considering the depressed level of the shares, investors may see large total returns in the years ahead if Rolls’ recovery really gains traction.
Rupert Hargreaves does not own any share mentioned. The Motley Fool UK has 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.