Rolls-Royce shares have had a roller-coaster 2020. They have tripled over the past few weeks. But they are still almost 50% down on the year so far.
The stock remains far from where it sat last year, when it was above 300p. I have become more optimistic on the engine maker’s shares. Indeed, I am tempted to buy them. But I have a few doubts, which make me think there are likely better opportunities elsewhere.
Rolls-Royce shares already have a lot of bad news factored in
It’s incredible to reflect that the shares fell as low as 35p in October. Clearly, the market has spent much of the year predicting various doomsday scenarios for the company. The jump in price since then has been a significant recovery. Nonetheless, the shares still trade far below where they started the year.
That reflects a lot of expected bad news for the company. With air travel markedly reduced, the demand for engine purchase and maintenance has fallen a lot. Meanwhile, even before the pandemic, Rolls-Royce had struggled over a number of years to turn a profit consistently. Companies which don’t make profits consistently tend not to be the sort of great dividend picks many investors like. Rolls has held its dividend flat for some years. With its heavy debt, even a good business performance might not equate to better shareholder returns. So, while Rolls-Royce shares have recouped some of their losses, I believe they are still priced quite cheaply due to bad news such as this.
2021 should bring positive momentum
But the outlook for the aircraft engine specialist may be better than the downbeat perception. Air cargo demand is high. I expect vaccination will accelerate the return of demand from airline passengers. The Trade body International Air Transport Association is forecasting 2021 passenger demand to be 50% higher than this year.
I expect that the coming year will bring sustained momentum for Rolls-Royce. Air travel demand is set to stage at least a partial recovery. The cost savings of the company’s recently announced reorganization should start to show impact. With perceived positive news on multiple fronts, I expect an upward rerating of Rolls-Royce shares.
Set against that, the newish management remains to be proven. Rolls-Royce still hasn’t demonstrated that it has a way to fix the profitability problems which have long plagued its business model. We also don’t yet know whether there will be a broader economic correction once the pandemic subsides. That could affect Rolls-Royce, whose performance relies heavily upon the broader trends of the global economy.
I’d pass over Rolls-Royce shares for other opportunities
So while I do see upside potential and expect Rolls-Royce shares to gain value from here, I don’t anticipate them getting back to 300p soon. Although I would think about buying Rolls-Royce, I would prefer to invest in shares I felt had stronger upside potential in the coming months.
While Rolls-Royce shares have positive momentum and drivers for further growth, the road ahead remains unpredictable. By contrast, some companies are firing on all cylinders and have a strong growth story. I would look for a company with those characteristics, currently lacking at Rolls-Royce.
christopherruane has no position in any of the shares 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.