The Rolls-Royce (LSE: RR) share price has slumped over the past six months. The stock is off around 11% since the middle of January. This has wiped out most of the company’s gains over the past year. The stock is now up just 2.2% over the past 12 months.
It’s impossible to pinpoint the exact reason why the stock has been falling recently. And if it’ll continue to do so.
However, it looks to me as if the market is starting to become concerned about the group’s recovery prospects. With new variants of coronavirus spreading worldwide, these could disrupt the aerospace industry’s recovery in the months ahead.
Bad news for the Rolls-Royce share price
Such a development would almost certainly be bad news for the company. Most of the engines it sells to the civil aviation industry are sold on maintenance contracts.
Under these contracts, Rolls only breaks even on the initial sale. The real money is made on the maintenance contracts sold with the engines. Unfortunately, these contracts tend to be linked to the number of flying hours each machine completes. Therefore, if aircraft are grounded, Rolls won’t get paid.
The above suggests that the company may miss its own target to return to cash flow break-even in the second half of 2021 if virus variants lead to additional lockdowns.
Of course, this is just speculation at this stage. The company hasn’t yet admitted it’ll miss its targets. Further, figures show that air travel has recovered to around 90% of pre-pandemic levels in the United States at least.
If this trend continues, I think the Rolls-Royce share price will likely find some support and slow its declines as the industry’s fundamentals continue to improve.
As the world’s vaccination programme continues to gain traction, I think it’s likely we’ll see this outcome. As long as passengers continue to fly, Rolls will continue to generate cash, which will support the group’s balance sheet and the share price.
Still, it seems that some investors disagree with this view. They appear to believe that the company’s outlook is deteriorating as new variants of coronavirus disrupt reopening plans. I think this remains a genuine risk to the firm’s prospects but, overall, governments seem determined to reopen economies, and I believe the Rolls-Royce share price will benefit from this.
At the same time, the company’s balance sheet is much stronger than it was this time last year. The immediate threat of bankruptcy has been removed. The group has billions of pounds of financial flexibility and headroom in its borrowing facilities. I think this provides the business breathing space to deal with further shutdowns, if necessary.
After considering all of the above, I think the Rolls-Royce share price will likely continue to decline as the market tries to digest news regarding virus variants. However, I believe the group’s fundamentals should only improve from last year’s devastation, which could drive the stock higher in the years ahead.
As such, I’d buy Roll-Royce shares for my portfolio today as a speculative investment.
Rupert Hargreaves 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.