For a brief period in late 2020, Rolls-Royce (LSE: RR) shares looked like they could be set to stage an amazing recovery. Between the start of October and early December, the RR share price rallied from 40p to 135p. Recently, however, the stock has lost its momentum again. Since its December high it’s fallen about 30%, while over a 12-month period it’s decreased by over 59%.
Here, I’m going to look at what has caused the share price to dip. I’m also going to look at whether the stock is a good fit for my portfolio.
Rolls-Royce: share price weakness
One of the main reasons the Rolls-Royce share price has fallen recently is that it’s become clear the airline industry is going to continue facing near-term challenges. This is likely to impact Rolls-Royce. That’s because it generates a substantial proportion of its revenues from the manufacturing and servicing of aero engines for the commercial aviation industry. Much of its income is linked to flying hours.
Back in November, when we got the news about the coronavirus vaccines, airline bookings immediately picked up. At the time, it looked like the outlook for the airline industry could improve substantially in the near term.
However, this year, that outlook has deteriorated again due to the new strains of the coronavirus and the new travel/quarantine restrictions governments have introduced. Worryingly, the International Air Transport Association (IATA) recently warned that the situation may get worse before it gets better.
Another reason the share price has dropped is that the company recently posted a rather disappointing trading update. Here, the company told investors it was expecting negative free cash flow of around £2bn in 2021. It also said 2021 widebody engine flying hours are expected to be around 55% of 2019 levels.
I’ll point out, however, it wasn’t all bad news. The company did say it expects to turn cash flow positive at some point during the second half of 2021. It also said that, with liquidity of approximately £9bn, it’s confident of overcoming those challenging near-term market conditions and is “well-positioned for the future.” This is certainly encouraging.
Should I buy RR shares?
At some stage in the not-too-distant future, I expect the prospects for the airline industry and Rolls-Royce to improve. Whether it’s later this year, or in 2022, I think air travel will pick up. This should benefit Roll-Royce. It could result in the share price moving higher.
That said, RR isn’t a stock I’d personally invest in today. As I explained recently, I like to invest in high-quality businesses that I believe have strong long-term growth prospects. I look for companies that are very profitable. That means producing a high return on capital employed, are financially sound and can demonstrate consistent top-line and bottom-line growth. This strategy suits my financial goals and risk tolerance.
Rolls-Royce, unfortunately, doesn’t meet my investment criteria. Looking at the company’s financials, its track record when it comes to profitability isn’t great. In recent years, it’s posted big losses on a number of occasions. This is a concern for me.
As I said, Rolls-Royce’s prospects could improve in the coming years. However, all things considered, I think there are other stocks I could buy right now that better fit my personal investment style.
Edward Sheldon has no position in any 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.