Over the past few months, I have written about Rolls-Royce (LSE: RR) shares on several occasions. Whenever I have covered the company, I have consistently concluded that its future is too uncertain. As such, I have decided to stay away.
That does not necessarily mean that I will be avoiding the company forever. I think the coronavirus pandemic has dealt the business a significant blow over the past 18 months, but it is still a world leader in the aerospace engineering sector. And I think this advantage will be critical in driving the firm’s recovery in the years ahead.
The outlook for Rolls-Royce shares
There are two things I want to see before I would be happy to buy shares in the aerospace company.
First of all, I would like to see a sustained recovery in global air traffic. Rolls sells its engines at cost and earns money on maintenance contracts that are linked to flying hours. The longer a plane spends in the air, the more money the group is owed.
Therefore, without a sustained recovery in global air traffic, the company’s sales and earnings will remain depressed. Rolls-Royce shares will not recover if earnings remain under pressure.
I also want to see a substantial pickup in demand for new aircraft. Airlines have been cancelling or postponing orders for new planes throughout the pandemic as they try to survive the crisis. This has understandably had a knock-on effect on the business. However, if carriers start to place new orders, we could see a sustained increase in the company’s sales and profits. This would almost certainly indicate the organisation is heading in the right direction.
In the best-case scenario, the world will begin to open up in 2022. Airlines will rush to make the most of pent-up consumer demand for travel and place new orders while bringing more planes back into service. And this jump in demand would translate into higher sales and profits for Rolls-Royce shares.
Risks and challenges
Unfortunately, it is impossible to say at this stage when either of the above will happen. There are some signs that the aviation industry is recovering in the US, but the highly profitable transatlantic route is still virtually grounded. And the same goes for the rest of the international travel market.
As these international routes are usually the most lucrative for airlines, they are unlikely to start placing new orders for aircraft until these routes are generating an income again.
At the same time, we do not know if or when another coronavirus variant will emerge and how dangerous this variant will be. A new variant could lead to renewed shutdowns, which would almost certainly set the group’s recovery back months and have a detrimental impact on Rolls-Royce shares.
So all in all, I would buy shares in the company when there is a sustained increase in air traffic activity. However, until we hit that point, I will be avoiding the stock.
